Electronic commerce embraces a wide range of internet-based business activity. An electronic catalogue on a website, from which the customer makes a selection of goods that are then delivered in the normal manner, is at one extreme. At the cutting-edge are digitised products, for example, the do-it-yourself CD, where customers can download digitised music to compile their CD of choice. Somewhere in the middle is the online retailer, such as Amazon.com, where the customer can browse through a catalogue, order online, pay online and where the dispatch of the physical goods is controlled electronically.
Tax legislation in the UK develops slowly. It was only last year that tax relief for the costs of keeping and maintaining a horse to carry out one’s duties was abolished, to be replaced this year by tax relief for the costs of keeping a bicycle. How is it coping with the exponential growth in both the quantity and the variety of e-commerce, and its increasing sophistication?
The issues, which are perplexing the tax authorities in the UK, include some administrative matters that are relatively simple to appreciate.
There is concern about taxpayers using the internet to conceal their identity, their location or the nature of transactions undertaken.
Encryption technology is also seen to pose a threat as taxpayers could use it to deny tax authorities access to their financial records (‘I regret that my clients have lost their electronic key’). Secreting funds offshore is also thought to be simpler because of the ease with which it is now allegedly possible to use the internet to open bank accounts in tax haven jurisdictions.
On the plus side, both the Inland Revenue and Customs & Excise operate excellent websites from which a wealth of press releases, technical information, booklets and guidance can be obtained. Both departments are committed to introducing the submission of tax and VAT returns over the internet.
Customs has a live pilot scheme this year for online submission of VAT returns.
The technical issues are not so clear-cut. Following the ministerial e-commerce conference in Ottawa, Canada last autumn, the UK tax authorities have reaffirmed their commitment to the following fundamental principles: neutrality (the tax system should be neutral and equitable as between electronic and conventional commerce); certainty and simplicity (taxpayers are entitled to be able to anticipate the tax consequences of a transaction); effectiveness and fairness (the right amount of tax should be levied at the right time); and flexibility (the tax system should be able to adapt to meet the developments in technology).
It is hard to argue with any of these principles, and indeed a cynic might see enormous advantages if they were applied to the UK tax system as a whole and not just in relation to the taxation of e-commerce. What is more difficult to accept is the current official stance that no new taxes need to be developed for the electronic era, as existing tax legislation will suffice.
Take the question of the ‘website on a server’, as it is, engagingly referred to in many of the discussions (the concept of a website not on a server being one presumably known only to the UK tax authorities). Companies trading in a global arena need to know which country can tax their profits.
The traditional tests are whether the company has a ‘permanent establishment’ in a particular country, in other words, a physical presence that is more than just a sales office.
Does a website on a server in a particular country amount to a permanent establishment? What if the company has many different servers in different jurisdictions, and it is purely a matter of luck to which server the surfer is routed? What if it is impossible to tell which server has been accessed in relation to any particular transaction?
Interesting tax planning possibilities present themselves, such as servers in tax havens on which space can be rented, or servers on satellites orbiting the earth, where the profits presumably escape taxation in any jurisdiction.
Perhaps the question really is whether tests based on physical presence are still appropriate in an electronic trading era where staff and resources are dispersed, all communication is computer to computer and physical meetings are a thing of the past.
The other big issue is the question of royalties. Most countries apply withholding taxes to royalties, that is, payments for the use of copyright and other intellectual property rights, where these are paid to a non-resident. These withholding taxes do not usually apply to payments for goods and services.
The difficulty is that many internet supplies do not easily fit into either category. If a customer pays a fee to download an image which he incorporates into a product of his own, is the fee a royalty for the use of copyright or is he buying an electronic product (or service). The OECD has already made considerable helpful amendments to the treatment of royalties on supplies of computer software, which aim to look at the substance of the transaction rather than its form, but this is only the beginning. Many countries fear that e-commerce will deprive them of revenues, and the imposition of withholding taxes is an easy way to redress the balance.
VAT has the advantage of being a more youthful tax and is arguably better equipped to deal with the challenges of e-commerce. The existing rules for intra-EC and international supplies of physical goods are able to deal with the added dimension of orders being placed over the internet, and the online store presents no real difficulties.
Supplies of services are slightly trickier, although supplies of services to business customers are already dealt with through the ‘reverse charge’ procedure. Suppliers to non-business customers are not covered by the reverse charge procedure, but then not every kind of service lends itself to cross-border supply over the internet. Who wants to have their UK self-assessment return prepared by a French accountant, or consult a dentist in Tennessee?
The most thorny issue for Customs is the supply of digitised products such as software, images and music to personal, or non-business, customers.
At the moment, there is no way that Customs can tax these supplies, nor is there any obvious way of plugging that gap.
Customs is taking a pragmatic approach at present on the grounds that this aspect of internet trading is, by volume, the smallest and least well developed.
Unfortunately, it is also one of the most attractive and innovative aspects of e-commerce, and is likely to appeal to customers in a big way when it does eventually take off.
We are constantly reminded that VAT is a simple tax. It was originally designed to deal with supplies of real goods in physical trading situations. Can VAT as we know it really meet the challenge of virtual reality, given the problems it has in dealing with other complex areas, such as land and property? Surely supplies of digitised products deserve a proper cybertax regime, nothing as crude as the now discredited ‘bit’ tax, but a system which recognises that these are not just supplies of goods or supplies of services, but something quite different.
Isobel d’Inverno is a chartered accountant and director of corporate tax at MacRoberts Solicitors, Glasgow.
New growth opportunities in Aberdeen, North East Scotland, are being invested in by Grant Thornton
If businesses do not take cyber security seriously in their business planning regulators may do it for them, the ICAEW has warned
The Financial Reporting Council has issued guidance regarding the annual reporting of 1,200 large and smaller listed companies. The letter highlighted the key issues and improvements that can be made in the 2016 reporting season
Deloitte's north-west Europe foray; BDO, Smith & Williamson investment paths; Shelley Stock Hutter; and Wilkins Kennedy discussed by editor Kevin Reed on our Friday Afternoon Live broadcast