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420 TAXATIONISSUESAlso, not all states treat items transferred online as tangi-
ble or intangible in determining which sourcing rules ap-
ply. Finally, under the e-commerce model where one piece
of equipment may be handling most of the sales, process-
ing, and delivery functions, it is not clear whether such
costs should end up being the determinant of where the
greatest costs of performance occur or whether employee
wages should be a more significant determinant. Discus-
sions here need to consider that equipment is generally
more mobile than personnel and the premise for deter-
mining what factors indicate that services and intangibles
revenue was generated in a particular location (or loca-
tions).Consumption Tax Perspective
Sourcing rules are also relevant for consumption taxes
to determine whether the transaction should be taxed at
the vendor’s location (origin basis) or customer’s location
(destination basis). In the United States, the states use
the destination approach to determine where sales tax
should be assessed. Other countries tend to do the same.
However, some have suggested that the origin approach
may be more suitable for online transactions, particularly
for transfers of digitized products and services. Where an
item is transferred electronically, it is far easier to deter-
mine and verify the vendor’s location than the customer’s
location. Thus, for compliance purposes, the origin ap-
proach seems to be simpler. However, others raise the is-
sue that the origin approach may result in a “race to the
bottom” where states reduce their sales tax rate to attract
businesses and in the process, hurt state tax revenue col-
lections. The origin versus destination issue will continue
to be discussed both at the state and international levels.Additional Tax Issues
The issues described previously are those most fre-
quently discussed in e-commerce taxation debates. How-
ever, there are a variety of other issues at all levels of
government. A few significant issues are briefly described
next.Web Site Development Costs
For income tax purposes, the law is not clear as to when
Web site development costs must be capitalized rather
than expensed. Also, if such costs must be capitalized,
what is the depreciable life? Although guidance exists on
the treatment of software development costs, it is not
clear whether all Web site development activities consti-
tute software development (a term that is not defined for
federal income tax purposes).Domain Names
There have been reported stories in the press of indi-
viduals selling domain names for significant amounts of
money. Often, the individuals have-registered many do-
main names in the hopes that some business will ap-
proach them to purchase a name at a premium. Tax is-
sues can arise for both the seller and buyer. The seller will
need to review the definition of a capital asset to determine
whether sale of the name produces capital gain income or
ordinary income. The buyer will need to determine whatthe depreciable life is for the name. Existing guidance on
depreciation of intangibles (Internal Revenue Code §197)
created in 1993 does not clearly provide an answer.Who to Tax
The issue of who to tax generally only arises for consump-
tion taxes. Although these tax rules are usually very clear
as to the answer, that answer may not be viewed as practi-
cal by the taxing jurisdiction. For example, although con-
sumers who are not charged sales tax on an otherwise
taxable online purchase where the vendor does not have
a physical presence in the state still owe a use tax, such
a tax is difficult to collect. States would much prefer to
be able to have vendors collect the tax (fewer taxpayers to
deal with) than try to collect the use tax from consumers.
The record-keeping burden and need to understand the
tax rules make it difficult to collect the use tax from con-
sumers.
The European Union, in particular, has been concerned
about the collection of value-added tax (VAT) on digitized
products and services sold by non-EU vendors to individ-
ual consumers in the EU. The issue is similar to that in
the United States of states being unable to collect use tax
from nonpresent vendors, and the desire of EU vendors to
“level the playing field” between online vendors and Main
Street vendors.
In 2002, the EU announced final rules to address the
concern. Under these rules, a non-EU vendor of digitized
items and services (such as software, games, and broad-
casts) must register in at least one of the 15 EU Member
States and collect VAT at the rate specified in the place
where the nonbusiness customer resides. Non-EU vendors
are not required to collect VAT from business customers
because such customers are to self-assess the VAT. The
U.S. Treasury has expressed concern over the EU rule,
noting that it creates a compliance burden and leads to
some discrimination in that in some EU States digitized
products are not taxed at the same VAT rate as the equiva-
lent tangible product. In addition, the Treasury notes that
EU vendors are allowed to assess VAT based on the rate in
the vendor’s country, which will lead to increased compe-
tition for non-EU vendors, who must charge a higher rate
in instances where the customer resides in a higher rate
jurisdiction. Finally, the Treasury notes that it would be
best for countries to act together to resolve these issues,
such as through the OECD, rather than resolve them sep-
arately (U.S. Treasury, 2002).Administrative Considerations
Tax authorities have identified a wide range of administra-
tive concerns that potentially exist in the e-commerce en-
vironment. These include issues of tracking transactions
where electronic money is used, existence of an audit trail,
viability of a digital signature system for tax filings, relia-
bility and verification of digital records, identification of
cross-border digital transactions, information reporting
when a typical reporting intermediary no longer exists,
reporting of small value bartering transactions (such as
for Web banner ads), and increased mobility of taxpayers.
The OECD and many countries continue to study many
of these taxation issues. Resolution of many of these issues
will take some time and probably global cooperation.