E-Commerce and Taxation: Understanding the Difficulties

Hamit Osman Olcay (*)


In just a decade of astounding growth, the Internet has reached a critical mass that is now attracting millions of consumers, and billions of their dollars, into a gigantic, ever-expanding virtual shopping mall. According to the figures published by VeriSign, which provides network security and authentication services to about 120.000 online retailers in the U.S., US$8.8 billion in online spending occurred during the period between the Thanksgiving holiday on Nov. 25 and the Monday after Christmas, Dec. 27, 2004. That constituted an increase of 24% compared to the same period in 2003. Not surprisingly, digital photograph equipment and entertainment were two of the fastest growing categories over the preceding year, with increases of up to 120% and 54% respectively. (1)

The magnitude of holiday season transactions in the U.S. clearly illustrates the potential of Internet commerce and how much this technology has been adopted by millions of consumers in the U.S. alone.

Tax systems, and particularly international taxation arrangements, can struggle to keep pace with globalization and market liberalization. Most of today’s tax arrangements were developed in an era when tax authorities could rely upon Exchange controls, highly regulated capital markets and technological constraints to protect them from the negative fiscal effects of global activities. These barriers to cross-border activities protected tax authorities from the full implications of the interaction between national tax systems. While corporations globalized, tax authorities remained constrained by national frontiers. (2)

However, today, the priority has to be to identify practical and reasonable ways of applying internationally accepted taxation norms to e-commerce; and, where necessary, of clarifying or developing those norms. The key here is to maintain and strengthen the international dialogue. There are existing VAT principles and collection systems that can be readily applied when it comes to B2B (Business to Business) transactions whether they may be domestic or international. Done domestically though, B2C (Business to Consumer) transactions do not present much of a problem either; since transactions take place in a single territory. (3)

Nevertheless, the issue of taxing electronic commerce on the Internet is complicated by several factors:

a. The existence of 191 different states member to the United Nations Organization (as of Dec. 20, 2005), creates a significant obstacle for compliance. The Internet is inherently susceptible to multiple and discriminatory taxation in a way that commerce conducted in more traditional ways is not. Double taxation would be inevitable because the borderless nature of the Internet makes taxation very tricky.

b. Since Internet commerce is still quite new, it can be quite difficult to figure out what the basic business model will look like in a few years. How can we know how to tax it? There are possibly many adverse unintended and unanticipated consequences lurking in the future.

c. How would the taxes be collected? One of the main benefits of Web-based businesses is that the availability to reach such a large potential universe of customers cheaply provides an opportunity for small one- and two-person companies to thrive without a tremendous amount of start-up capital. The cost of compliance and tax collection alone for these small businesses could be enough of a deterrent to keep them from participating in the marketplace. Clearly, compelling retailers to collect tax under existing jurisdictional regimes would place a significant burden on merchants; and such a burden would likely not be uniformly felt across all retailers. According to Ernst and Young, a prominent accounting firm based in the U.S., the estimated cost of compliance of small businesses will be close to 87% of the sales tax they collect, in contrast to 14% of the tax collected by large businesses. (4)

d. Another major enforcement issue is identifying the state, country or countries that have tax jurisdiction over income generated by electronic transactions. Electronic commerce permits a foreign person to engage in multiple business transactions with customers in several countries without ever having to enter one of them. This is important; since the supplier has no presence at all in the jurisdiction of the customer. Self-assessment by individuals is never a great way to secure this sort of tax – but looking to the supplier to collect the tax, as is the norm for VAT type taxes, is not so easy either because the supplier is in another country

e. Furthermore, is it desirable to have a taxation scheme that, to be effectively implemented would systematically undermine our privacy by amassing a comprehensive database on our online purchases so that some government agency can be certain that we paid our relevant taxes?

In addition to the above; other considerations stemming from technological realities must also be taken into account in order to determine whether an Internet transaction may be deemed taxable; and if so, which party is liable for the tax.

The geographic location of computers upon which transactions are processed (webservers) and ownership issues relating to these servers further complicate the matter:

Webservers are computer systems attached to the Internet, which host many web-sites and the databases required for their effective functioning. These servers may exist in any place or country, without affecting the operation and effectiveness of the websites they may be hosting. In order to be able to tax the commerce generated on the websites hosted on its webservers, hosting companies must have a “permanent establishment” (the rule which determines the right of a state to tax the profits on an enterprise of another state) status. From a business point of view, websites, which comprise of databases and software do not constitute “real property” and hence, do not constitute permanent establishments on their own. For an Internet-based business to be liable for taxes, it must either posses ownership or lease of the webserver containing its website. However, the ability to quickly transfer a website and its database to another webserver in another country does not allow for governments to easily track and force Internet businesses to pay most of their taxes. (5)

Still, conclusions can be drawn taking into account of the “Permanent Establishment” criteria and the nature of services provided over the Internet by on-line companies. These are;

1. Irrespective of their geographical location, computers utilized for introducing and promoting goods and services cannot constitute a ‘Permanent Establishment’ for a company.

2. There is much debate as to whether computers that collect user data and credit card details, in addition to promoting goods and services, can constitute a ‘Permanent Establishment’ for an on-line company.

3. However, the possession of a computer that introduces and promotes digital goods that can be delivered on-line following collection of user and credit card details should constitute a ‘Permanent Establishment’ for an on-line company, in the country where that computer is located.

Are there any widely accepted basic principles in connection with taxing e-commerce?

Among the many bodies exploring Internet taxation and other issues are OECD ‘Technical Advisory Group on Monitoring the Application of Existing Treaty Norms for Taxing Business Profits (the "Business Profits TAG"), set up by the Committee on Fiscal Affairs in January 1999 with the general mandate to “examine how the current treaty rules for the taxation of business profits apply in the context of electronic commerce and examine proposals for alternative rules”, the U.S. ‘Advisory Commission on E-Commerce’ , established in 1998 under the Internet Tax Freedom Act, and the WTO, which has been carrying out a work programme in accordance with the ‘Declaration on Global Electronic Commerce’, adopted in 1998. Although differences among these bodies in approaching e-commerce taxation still prevail, convergences on some basic ideas do exist, namely;

  • the non-discriminatory treatment of e-commerce;
  • the application of existing rules and concepts;
  • the importance of a fair sharing of the tax base internationally;
  • and a commitment to pursuing these ends through intensified dialogue with businesses and all international actors.

Conclusion: The road ahead

E-commerce can and will be taxed – the important thing is that it be taxed fairly and efficiently (just like conventional commerce). Governments will not and cannot remain oblivious to the potential revenue derivable from taxing e-commerce. Therefore, it will be up to governments to come up with new and feasible taxing methods which will allow for consumers and businesses alike to easily comply with their duties as taxpayers. New software and electronic tracking systems will without doubt be helpful in this respect. However, opponents of e-commerce taxing will continue to argue that; a) taxes already exist for the acquisition and use of electronic equipment and access to the Internet, b) the numbers of on-line businesses and employees are swelling – most of them taxable on their income, c) taxing e-commerce might spell death for fledgling businesses. (6)

The question before us is not about whether to tax e-commerce, but how and to what extent?


1. Tom Krazit: “Online shopping up 24 percent this year”, January 3, 2005. http://www.thestandard.com/moabletype/datadigest/archives/003189.php  2. Jeffrey Owens: “Taxation in a global environment”, March 2002. The OECD Observer.
3. David Rooney: ”E-commerce and taxation: a virtual reality”, February 2001. The OECD Observer.
4. Orson Swindle: “Taxation of E-Commerce”, October 15, 1999. Address to the Browning Symposium – University of Montana. http://www.ftc.gov/speeches/swindle/montana.htm
5. Eser Sevinç: “Elektronik Ticaretin Vergilendirilmesi”
6. Stephen Kroes: “Electronic Commerce: Money Loser or Revenue Generator for Government?”, October 1999. http://www.caltax.org/MEMBER/digest/

(*) Daire Başkanı, Enformasyon Dairesi Başkanlığı (Internet), Dışişleri Bakanlığı