E-Commerce Tax Planning

7/27/2019 E-Commerce Tax Planning

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Connecting with E-Commerce

E-commerce continues to change all parts of a business's supply chain from procurement, research and

development, to manufacturing, distribution and sales. But unwitting tax exposure may be created and

equally costly efficiency opportunities may be lost if the implications of any change are not considered

properly.

For a multinational group, the opportunities and advantages produced by new business patterns can be

significant. For example:

The greater connectivity offered by e-commerce allows for manufacturing and distribution

arrangements to be made more tax efficient.

Shared service centers, contract research and development, etc., also offer significant tax savingsopportunities.

There is often considerable flexibility in locating servers, web sites, call centers, etc., to minimize

taxation burdens at point of sale.

Tax planning structures that take advantage of these mechanisms are considerably more robust when

aligned to and complementing an evolving business model.

Thomas Borstell(Germany),Hanspeter Kurz(Switzerland) andJohn Dixon(UK) look at the main issues in

this constantly evolving area.

When a business trades across borders and sells goods or services over the Internet, in what circumstances

can the country in which the customer is located levy taxes on the profits of the supplier of those goods and

services?

Double tax agreements (DTAs) based on the OECD model will provide that a business conducted by a

resident of one jurisdiction should only be subject to tax in the other jurisdiction to the extent that it trades in

that jurisdiction through a permanent establishment (P/E). Put another way; in what circumstances can it be

argued that a P/E is created when sales are made electronically?

What's a "fixed place of business"? The difficulty here is that with the exception of certain agency

relationships the definition of P/E in OECD model-based DTAs traditionally focuses on the concept of a

"fixed place of business". There are some obvious problems in seeking to consider whether a trader creates

a fixed place of business when it trades electronically.

This is an important issue that goes to the root of international norms relating to the taxation of cross border

business. Countries that are net importers of goods and services have cause for concern as they may find

that tax revenues fall as the tax base is eroded by e-commerce. The flexible manner in which an e-

commerce trade can be organized and the lack of substance or infrastructure that needs to be established in

the jurisdiction of the customer in order to ensure that a sale occurs means that any "solution" to avoid or
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lessen base erosion will be arbitrary at best and will not necessarily find favor with net exporting countries

such as the US.

The German view. Even though governments have largely delegated the task of deciding on an approach

to the OECD, in reality the need for decisions is overtaking the debate.

Continued...

For example, the German definition of a permanent establishment is laid down in S12 of the German Fiscal

Code, and is broadly similar to the definition given in Art. 5 of the OECD Model Treaty. There is at least one

difference: Under the German tax code, a permanent establishment is also considered to exist if the

activities performed are of an auxiliary or preparatory nature. In practice, however, the definition in the

relevant DTA would take precedence.

Is e-commerce "permanent"? The German authorities have not published final regulations on whether e-

commerce activities constitute a permanent establishment. But in 1998 a regional tax authority published a

specific ruling dealing with the question of whether the installation of a server constitutes a permanent

establishment. The case concerned an offline structure in which the activities were restricted to advertising,

providing communications links and for information purposes.

The authorities decided that the server did not qualify as a permanent establishment in the sense of Art. 5 of

the OECD Model Treaty, but the activities were "preparatory and auxiliary" according to Art. 5 (4), so under

domestic legislation a permanent establishment would exist. Even before this case, the German supreme

tax court decided (in what is known as the "pipeline decision" of 1996) that a permanent establishment might

be constituted if the business is carried on with automatic equipment that does not require human

intervention.

It follows from this case that a server, which works automatically, might also be considered as a permanent

establishment if the functions carried out on this server are "core functions" of the enterprise.

The concept of residency. Another matter of concern is the concept of residency. With increased use of

email and video conferencing, it is often proving difficult to determine where a company is controlled and

managed. This concept is used by a number of jurisdictions in a variety of guises to determine where a

company is resident for tax purposes and the concept of "effective management" is also used in DTAs

based on the OECD Model to determine where a company is resident for treaty purposes.

Characterizing Income

Where digitized product such as software is "sold" over the net, what is the tax treatment of the transaction?

In particular: Is it a sale, or license or service?

Despite the fact that the legal form of the transaction may be viewed as a license because rights to some

intellectual property are retained by the supplier, in economic terms the transaction may be more akin to a

sale. The problem is compounded if a bundle of items are delivered.

The potential of double taxation. The difficulty here is that the direct tax profile of the transaction can

change dramatically depending on how the transaction is viewed. This can give rise to the potential of

double taxation: What if the jurisdiction of the customer classifies the transaction as a license and requires a
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withholding tax on gross royalties, yet the country of residency of the supplier views the transaction as a

sale?

For instance, the payments derived from e-commerce activities might be qualified under the German tax

code as trading income, rental income (license) or other income. Specific regulations concerning e-

commerce activities do not exist yet.

The "satellite case." However, last year, the German supreme tax court decided the so-called "satellite

case," in which a German television company engaged a foreign satellite operator to transmit its

programming to German TV viewers. Both parties agreed that the operator should work with a specific

satellite-transponder.

The issue in this case was whether the television company's payment to the foreign satellite operator was

trading, rental or other income. The German tax court decided that it qualified as trade income, because the

main content of the agreement between both parties was to guarantee that viewers could receive the TV

company's programs and not the right to use the equipment of the satellite operator.

Application of VAT. As always, from a VAT point of view, the critical distinction is between the provision of

goods and the provision of service, with most of the difficulties relating to the latter. As far as the provision of

services is concerned, the "place of supply" determines the application of VAT. There is no uniform rule for

all services.

Where the place of supply is the jurisdiction of the customer, business-to-business transactions are dealt

with under the "reverse charge" by which the customer effectively accounts for VAT. In the business-to-

consumer area, however, the potential for VAT leakage occurs. Recently, the UK's Customs and Excise

succinctly described the problem, as follows:

"In contrast to goods that cross borders physically and can be identified easily, digitizedproducts can be bought and sold across borders without any obvious indication of a

transaction having taken place. For businesses that are required to keep books and

records, and where the government has a right of audit, this does not present obstacles.

On the other hand, sales from mother countries to private consumers can cause

problems. It is important to find simple and effective ways in which VAT can be self

assessed and collected on digitized products."

Formal requirements. From a VAT perspective, great care needs to be taken that the formal requirements

of invoicing and import/export documents are fulfilled; in most cases, this necessitates physical paperwork

even if all of the information flows, the invoicing and the payments are electronic.

Not everything changes because of e-commerce, however. Companies should not lose sight of the

straightforward planning issues that affect any structure. For example, a group might consider Switzerland

as a location for a profitable venture. In many cases, it may be possible and very advantageous to get a

ruling for taxation according to a privileged tax status (domiciliary or mixed company), resulting in an

effective tax rate of between 8% and 10% on income from non-Swiss sources.


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The availability of these tax privileges makes Switzerland a very attractive place to locate an e-business

operation. But in the start-up phase, most e-business ventures result in losses that may be substantial.

Since the loss carry-forward period in Switzerland is restricted to seven years, loss planning becomes a

critical task and it is important that the opportunities offered by the Swiss tax laws regarding capitalization

and depreciation are seized at the optimum moment.

Interaction with Customers and Suppliers: Transfer Pricing

One area in which e-commerce is clearly changing is how companies interact with customers and suppliers.

This has a knock-on effect on the business processes within the company:

Electronic order acceptance has implications for where and how contracts with customers are concluded.

Many sales contracts once concluded locally will be made through a centralized on-line ordering facility that

can be located almost anywhere, with little or no human intervention.

Order fulfillment is changing too, in response to heightened customer expectations arising from electronic

ordering. This calls into question the role of the local sales subsidiary, which once made sales in the local

market and probably acted either as a buy-sell distributor or possibly a commissionaire. Today, there is a

trend for it to act increasingly as a service providerand, frequently, it will not be necessary or desirable for

it to participate directly in making sales.

The rise of intranets. The development and use of intranets between affiliated companies has resulted in a

growing trend: greater collaboration between group members on the production and sale of a particular good

or service. This potentially puts further pressure on transfer pricing methodology and the objective of

remunerating group members on an "arm's length" basis.

In many cases, it becomes increasingly difficult to measure the contribution by separate parts of a global

business in "traditional arm's length" terms, as comparables are often not available.

"Profit split" method. Under these circumstances, sometimes as a matter of expediency, "profit split"

methods increasingly come into consideration. Unfortunately, this increases the risk of disagreement

between jurisdictions, not only to the use of a profit split method but also regarding the factors to be applied

in determining an allocation of profits. Certain jurisdictions are noticeably more antagonistic to profit split

approaches than others.

On the procurement side, a huge amount of purchases will be made on-line in future, often through

electronic exchanges or markets. On-line auctions are delivering huge price reductions and are bound to

grow rapidly. These new electronic purchasing tools profoundly affect how companies plan and execute their

procurement strategies.

Tax directors need to participate in the development of these new processes and tools. There is a window of

opportunity to structure these processes in a tax efficient way and to ensure that new tangible and intangible

assets that are created are owned and exploited tax efficiently.


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E-Commerce Tax Planning

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