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TAXISSUESRAISED BYE-COMMERCE AND THEINTERNET 419and phone bills still include excise taxes even if part of the
phone usage was to access the Internet.
Finally, the Act included a declaration that no new fed-
eral taxes similar to the state and local taxes covered by
the Act should be enacted with respect to the Internet and
Internet access during the moratorium.Characterization of Income
At the international level, a Technical Advisory Group
(TAG) set up by the OECD has issued guidance on clas-
sifying the type of revenue for purposes of being adopted
as commentary to the OECD model tax treaty. The report
(OECD, 2001) points out that the issue of determining
whether payments are for business profits or royalties is
not a new issue. Instead, this has become a more com-
monplace issue with the advent of e-commerce where it
is easy to transfer digital items.
The main issue is to distinguish when the making of a
copy of a digital item represents royalties for use of a copy-
right rather than normal business profits. Because the act
of copying involves use of the copyright, some countries
have taken the position that the payment is a royalty. The
TAG recommends that where a payment for a digital item
is made so that the buyer can use and enjoy the item, the
use of the copyright is an incidental rather than primary
purpose of the payment and should not be the focal point
to characterize the payment.Where to Tax—Sourcing
International Perspective
At the international level income sourcing rules dictate
whether income is taxed in the country of residence or
source. Tax treaties typically provide that the source coun-
try has preference over the resident country in taxing busi-
ness income if there is a PE in the source country (rules
may vary for other types of income). Several countries
have noted in reports on e-commerce tax issues that the
sourcing rules may need to be revisited for some types of
e-commerce transactions. Coordination of sourcing rules
is needed to avoid double taxation of income (such as
where income is taxed both in the country of residence
and source).
In 1996, the U.S. Treasury issued a report that included
the following suggestion:The growth of new communications technolo-
gies and electronic commerce will likely require
that principles of residence-based taxation as-
sume even greater importance. In the world of
cyberspace, it is often difficult, if not impossible,
to apply traditional source concepts to link an
item of income with a specific geographical loca-
tion. Therefore, source based taxation could lose
its rationale and be rendered obsolete by elec-
tronic commerce. By contrast, almost all taxpay-
ers are resident somewhere. (U.S. Treasury, 1996,
¶7.1.5)Most countries did not embrace this perspective and
the Treasury Department later backed down from the
statement. One concern was that because so manyonline vendors are located in the United States, the United
States would gain revenue from a residence-based sourc-
ing system for e-commerce.
Countries may see a loss of revenue because the e-
commerce business model does not require a physical
presence (property or employees) in a location in order to
serve customers at that location. For example, a multina-
tional company may be able to eliminate a PE in a country
by closing a sales office and having customers purchase
online while the taxpayer’s equipment is located in a low-
tax country.
Another international “where” issue exists for some
multinational businesses when more than one country
treats the business as a resident. Under the OECD model
tax treaty, a business is deemed to be a resident of the
country where its place of effective management resides.
This is the location where key management and commer-
cial decisions are made—typically the location of the key
executives. A business may have more than one place of
management, but under the model treaty, it will have only
one place of effective management based on the facts and
circumstances.
The e-commerce business model challenges the deter-
mination of the place of effective management because
key executives may not all be in the same location and
may not be in the location where key business operations
are conducted.
Discussion of the issues of sourcing international busi-
ness income will continue. Global cooperation in estab-
lishing rules will prevent double taxation and, perhaps,
undue competition among countries. The OECD and its
TAGs continue to work on identifying the issues and pos-
sible solutions. The draft and final reports are available at
the OECD web site (OECD, n.d.).State Income Tax Perspective
Sourcing rules are also relevant at the state level to deter-
mine which state (or states) may assess income tax on a
multistate business. These rules are typically different for
income from sale of goods than for services and intangi-
bles.
Today, for income tax purposes, most states source
sales of tangible products to the destination state (in most
states, if the seller is not subject to tax in that state, the
sale is “thrown back” to the state of origin). Sales of intan-
gibles are typically sourced to the state where the greatest
income-producing activity occurs. However, a few states,
such as Minnesota, source revenue from services and in-
tangibles to the state where the service is received or the
intangible is used by the purchaser.
While almost all of the discussions concerning state
taxation of e-commerce focus on sales and use taxes, there
are also several state income tax issues, particularly with
respect to sourcing of income from e-commerce vendors.
With respect to intangibles, not all states determine the
location of the greatest income-producing activity in the
same manner. Some states look at where the greatest cost
of performance occurs, while other states prorate income
based on the portion of the costs of performance that oc-
cur in the state. In addition, states do not consistently
measure the costs of performance in that some only con-
sider direct costs while others also include indirect costs.