Ecommerce Taxation: A 21st Century Problem

Ecommerce might be one of the greatest innovations of the last decade, as it holds a certain weight of responsibility for improving the way the internet runs. We like to think that for the most part, society has adapted to the changes that have come about as a result of technological advancements. However, as much as we’d like to think that we are “up-to-date”, currently there are millions of people across the globe that are selling products and services, just like any other business, but there are tax discrepancies that allow online sellers, in global transactions, to take home their earnings without paying tax.

There is one glaring problem with international tax rules on ecommerce transactions – currently the focus is on territorial and source based tax jurisdiction. The issues that stand in the way of taxing ecommerce transactions are legitimate: global, borderless, anonymous, and “located virtually”. Are these issues insurmountable? Certainly not, however every year that the OECD, and leading economic powers wait to find a feasible solution to the issue, the more difficult it will be to implement a successful solutions.

In the world of cyberspace, it is often difficult, if not impossible, to apply traditional concepts to link an item of income with a specific geographical location. Therefore, source based taxation could lose its rationale and be rendered obsolete by electronic commerce. By contrast, almost all taxpayers are resident somewhere. – Richard Musgrave, Tax Equity with Multiple Jurisdictions

The Challenges

With ecommerce being both global & borderless arises first and foremost an issue with tax enforcement. eCommerce in its nature is global. A person can have a product for sale stored and shipped from New York, while living 365 days a year in Italy, or moving every month from country to country, while the tangible product stays put. In either case, obviously the current tax regime (permanent establishment and source-based income) doesn’t make a convincing argument for successful and just ecommerce taxation.

The global character of e-commerce makes it difficult for any one country to monitor and tax e-commerce income. International cooperation is needed to handle e-commerce taxation, but such cooperation is not easy, given the conflicting interests of different countries. – Rifat Azam; E-Commerce Taxation and Cyberspace Law: The Integrative Adaptation Model

If we go back to the aforementioned example, which nation(s) would carry out the taxation? The problem is that the field is so dynamic that there can be almost no “general rules” that can actually be assimilated. Even if there was an agreement between a vast number of nations, there is still the issue of “anonymity” that does not allow for governing bodies to know who is carrying out transactions. In addition, forget tangible products. How do you go and tax digital services? Using the IP address would be as ludicrous and as trustworthy as a politician running for election. 

Even if transactions were not anonymous (we can change that via “Code is Law”), knowing and defining “location” would be a key aspect in creating a resolution. There are those that will claim that e-commerce occurs “on the internet”, and thus there is no current body that has jurisdiction to tax the transactions. This brings us to the discussion as to who “controls” the internet, which questions the legitimacy of taxing and regulating online, borderless transactions. 

LEGITIMACY

The cyber-libertarians have a point. The cyber-skeptics have a point. Neither side will budge (remind you of any other two polar opposites, elephants and bears?). John Perry Barlow went to an extreme point of cyber-libertartianism in his “Declaration of the Independence of Cyberspace“, that one (I) could compare to the opinion of those that think that any tax on property is a direct violation of one’s property rights – which we all know isn’t so.

One’s property rights, have to some extent, grown as a result of state action. Undoubtedly, the same is true for the interntet that we use today. Without government involvement back in the 1990’s there would be no ecommerce market. The degree at which transaction can be taxed on ecommerce platforms is a different discussion, and one that would leave space to create different, and maybe lower, tax rates. 

Solutions

The first step in solving the issue in the current tax regime is adaptation of technology, mainly code, into the laws that pertain and govern ecommerce. While searching for a solution, the fear of double-taxation has to be taken into account, as well as the stance of those that claim that the internet “is its own place” that is governed by the people. 

Who should create the legal pathway to carrying out a solution? The OECD? Should it be via multi-lateral tax agreements? Do we need an independent global tax fund? Is the Inegrative Adaptation Model the answer?

The Integrative Adaptation model was first proposed by Dr. Rifat Azam, and seeks to bring together cyberspace law and the current law, with four layers of adaptation:

(1) developing income-classification rules and residency rules by case law,

(2) introducing new source rules based on the location of the parties to the transaction and the physical income-production components,

(3) using technology to apply the tax regime to ecommerce,

(4) gaining international consensus through international treaties. The Integrative Adaptation Model is appropriate for taxing international e-commerce income.

The model seems to make sense, although defining the different parameters will not be simple. The model was introduced in 2007, however it has not been implemented. Just as this model has not been implemented it is highly unlikely that any other models will by widely accepted by a~large groups of nations. So why not add the model to multi/bi-lateral tax agreements? 

Via that route, there would still be transactions that are able to continue to exist outside of the tax loop, however it would be taking a step-forward in the right direction. For example, if the United States and the United Kingdom were to create an agreement that were to go into effect in two years, in which case anonymity of sides was lifted, we could begin to see the evolution of a better tax regime. If successful, sides could either add a similar/same model to other agreements, until wide international acceptance is reached. 

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At the end of the day, the longer we wait the more difficult it will be to find an efficient solution to collecting taxes from ecommerce transactions. Globalization is not slowing down. The number transaction and amount of money made in ecommerce on a yearly basis is only going to increase. It’s up to current international bodies, or a new one – as suggested by Azam – in order to find a way to collect a tax on the growing cross border (global) ecommerce transactions that could account for more than 20% of all transactions on the net in the near future.

Photo Credit: Daniel Broche