Corporation tax (income tax) is levied on the profits of an
incorporated business. Some countries tax companies based on place of
incorporation (legal establishment), but more usually tax applies to a
‘permanent establishment’. As with individuals, the taxing country will
normally attempt to tax a company’s world-wide income once it has
demonstrated permanent establishment. Income arising in other countries
is often subjected to local withholding taxes before remittance; or of
course it can easily happen that more than one country will assert
permanent establishment, leading to double taxation. These situations
are sorted out through the network of double taxation treaties which
most high-tax countries have entered into.
IOFCs, International Offshore Financial Centres, by and large do
not have double tax treaties, not least because they usually have very
low or no corporation tax. Companies have often attempted to escape tax
by earning profits in subsidiary companies in IOFCs and not remitting
it to the mother company; almost all high-tax countries have
anti-avoidance ‘controlled foreign company’ laws which attribute such
income to the mother company.
Within this (highly over-simplified!) framework, what is the effect
of e-commerce? Whereas previously, in order to trade in a country, it
was necessary to have some or all of staff, an office, a warehouse, and
means of delivery, these things can be to some degree avoided with
e-commerce. A customer can inspect and buy goods or services on a
company’s Internet site (no local record of the sale is created), using
money from an offshore account or an electronic credit card (no local
trace of the transaction is created), and delivery of the goods can be
outsourced to a third party. In fact, in most countries, a simple
warehouse and delivery operation does not constitute a permanent
establishment so that the outsourcing may not be necessary.
The placing of the Internet server from which (on which, if you
like) the e-commerce transaction happens, is probably important: some
cases have already suggested that a server may constitute a permanent
establishment; others suggest that it doesn’t. Of course, the server
can be anywhere, and specifically, it can be offshore. If the goods or
services are deliverable digitally (eg music or software) then there is
no physical trace whatsoever of a transaction in the jurisdiction which
would like to tax it.
The OECD has established a working party to study the question of
web servers and the possible need to re-define the concept of the
permanent establishment. It has conducted two rounds of consultation,
the second having closed in June 2000, and is expected to bring forward
recommendations at its meeting in September 2000. Its interim report
seemed to be moving in the direction of agreeing that servers would not
constitute permanent establishments.
As well as ‘dematerialising’ transactions, the Internet allows a
company to have its various departments scattered almost anywhere, but
permanently connected through the web. It will become increasingly
difficult to say exactly where a company has its ‘main’ base, because
it often won’t have one. In an extreme case, a company can base itself
entirely in one or more IOFCs, outsourcing all those elements of its
business which require physicality. For this reason, the OECD’s agenda
includes the question of whether the concept of the permament
establishment is now outmoded.
Governments, which haven’t so far been much affected by e-commerce,
are nonetheless very concerned about the future. How can a Government
collect tax on profits resulting from transactions which it can’t see
or measure, carried out by a company which doesn’t exist physically on
its soil? Intrusive and heavy-handed attempts to ‘police’ the Internet
or its use have already been quickly seen off, and most Governments
seem to understand that such behaviour will simply result in the
isolation of their countries from the rest of the world.
Of course, eventually a solution will be found to tax Internet
transactions in a fair way, and it is no doubt correct that this should
be the case; but while the search continues there are going to be
multiple, completely legal ways for companies to take advantage of the
confusion in order to reduce their tax bills.