Taxing E-Commerce in a Global Economy Old Issues

Taxing E-Commerce in a Global Economy: Old Issues, New Media, New Opportunities presentation to Advisory Commission on Electronic Commerce by Peter R. Merrill Pricewaterhouse. Coopers LLP Williamsburg, VA June 22, 1999

2 Contents Ø What ØA is e-commerce? brief history of e-commerce Ø Some Ø Tax facts and figures policy implications Ø Suggested principles to guide tax policy

3 What is e-commerce? A broad definition Ø Interactions possessing three attributes: (1) between two computer applications, (2) completes all or part of business transaction, and (3) crosses enterprise boundaries. Ø Includes business applications over VANs that have been used for decades Electronic data interchange (EDI) Ø Credit card and debit card transactions Ø Ø Electronic fund transfers (EFT)

4 What is e-commerce? A narrower definition (i-commerce) Ø Limited to business applications over open networks using non-proprietary protocols such as the Internet Ø Defined narrowly, e-commerce is barely four years old! Ø Includes b 2 b applications over open networks as well as b 2 c applications

5 What is e-commerce? Ø Business-to-consumer (b 2 c) examples Retail -- catalogue, configuration, sale, payment Ø Broker, agent -- auction, travel, auto, real estate Ø Entertainment -- gaming, gambling, music Ø Communications -- e-mail, e-cards, net radio Ø Financial services -- securities, insur. , banking Ø Publication -- newspapers, magazines Ø Database -- directories, maps Ø Professional services -- “tele-medicine” Ø Education -- “distance learning” Ø

6 History of e-commerce Source: OECD, The Economic and Social Impact of Electronic Commerce, 1999.

7 History of e-commerce Ø E-commerce is more a way of doing business than a sector Ø “In five years, there won’t be any Internet companies because they will all be Internet companies. Otherwise, they will die. ” -- Andy Grove, Intel Ø Prior changes in communications technologies also have led to evolution of business models Ø telegraph, telephone, radio, TV, facsimile, etc.

Facts and figures U. S. i-commerce sales B 2 c gets the headlines, b 2 b gets the dollars Ø b 2 b accounts for 85%+ of sales in 1999 Ø Much higher if we count EDI, EFT, etc. Ø b 2 b is projected to grow much faster, reaching over 90% of i-commerce by 2001 Ø b 2 b migration from VANs to the Internet permits cost effective use by smaller enterprises (“EDI lite”) Source: Forrester Research Inc. , Nov. 1998 8

Facts and figures b 2 c is a small share of Internet commerce 9

Facts and figures US direct market sales to consumers E-commerce is a tiny share of direct market sales Internet sales to consumers are less than 3% of all direct market sales to consumers (est. 1999) Ø Internet sales to consumers amount to less than 4/10 of one percent of U. S. personal consumer expenditures (est. 1999) Ø 10

Facts and figures Internet is a tiny % of direct market consumer sales 11

12 Facts and figures To date, Internet companies have small profits Combined total from most recent financial statements of 15 large Internet companies: * Revenues $5. 1 billion Net income $-0. 4 billion *Amazon, AOL, CDnow, Compu. Serve, E*Trade, e. Bay, Excite, Infoseek, Lycos, N 2 K, Net. Grocer, ONsale, Pea. Pod, Preview, Yahoo!

13 Facts and figures International revenues are significant for some U. S. firms

14 Facts and figures Ø U. S. dominance of global e-commerce market is projected to decline Ø Mid-range estimates put U. S. share of global commerce sales at Øabout 80% in 1999 Ødeclining to less than 60% in 2003. Source Forrester Research Inc. , 1998 i-

15 Facts and figures

16 Facts and figures Ø E-commerce is contributing to U. S. economic growth by raising productivity Improved supply chain management and reduced inventory costs Ø Reduced distribution, marketing, and customer service costs Ø Ø The OECD estimates b 2 c commerce potentially will increase total U. S. factor productivity by 0. 50%-0. 67%

17 Tax policy implications Ø Don’t let advocates of radical tax change use e-commerce as a pretext. Remote sales have been with us since at least the Sears & Roebuck catalog Ø The Internet is a tiny share of remote sales, and a negligible percentage of all consumer sales Ø Excluding services (which generally are not subject to retail sales tax), most b 2 c Internet sales are delivered exactly like mail order Ø

18 Tax policy implications Ø The tax system can cope with e-commerce. Though the medium is new, the issues are old. See Howley v. Whipple, 48 N. H. 487 (1869) in which the court opined that writing and signatures communicated electronically through the telegraph were equivalent to pen and ink. 1 1 See: Boyle, Peterson, Sample, Schottenstein, and Sprague, “The Emerging International Tax Environment for Electronic Commerce, ” Tax Management Memorandum, February 18, 1999.

19 Tax policy implications Ø Currently, tax revenue losses due to commerce (if any) are very small Ø Goolsbee and Zittrain (1999) estimate that sales tax revenues are reduced by less than 1/4 of 1 percent in 1998 ØLess Ø if Internet substitutes for mail order This does not take into account offsetting revenue gains due to ØProductivity growth from business efficiency gains ØStock market gains spurred by e-commerce Ø e- Potential revenue loss from direct taxes also is minimal due to current absence of profits.

20 Tax policy implications Ø E-commerce highlights a number of anomalies and weaknesses in tax systems Federal and state telecommunications taxes have become outdated due to deregulation and convergence of technologies Ø The current system is too complex Ø Ø 30, 000 potential sales tax jurisdictions in US! Forexia case (UK VAT). Delivery of a newsletter as a hard copy vs. e-mail or fax. Ø Jurisdictions must coordinate to avoid doubletaxation of border-crossing transactions Ø

21 Tax policy implications Ø Market-driven technological developments will provide tools for assuring tax compliance Ø “Many software manufacturers and e-business merchants would like to be able to identify clients uniquely. ” 1 Tax administration should follow, not lead, technological development of e-commerce. Ø Business participation in development of tax standards is essential. Ø 1 Pricewaterhouse. Coopers, E-business Technology Forecast, 1999, p. 192.

22 Tax policy implications Ø E-commerce technology has the potential to dramatically lower costs of business to tax administrator (b 2 a) transactions Electronic tax registration Ø Electronic tax filing and payment Ø Dissemination of tax information on government web sites Ø

23 Tax policy implications Ø Tax administrators’ fears that electronic records are more easily altered are without foundation. For commercial reasons, firms must ensure the security and integrity of their electronic transactions and records Ø Sophisticated auditing procedures are being developed for use by internal and external auditors, who must satisfy themselves of the integrity of electronic systems and records. 1 Ø 1 Pricewaterhouse. Coopers, “The Technologies of Electronic Commerce: The Integrity of Electronic Transactions and Digital Records for Tax Administration and Compliance, ” prepared for the Electronic Commerce Tax Study Group (August 1998).

24 Tax policy implications Ø Tax authorities should not discourage new technology to protect familiar ways of doing business. Ø Such measures will reduce potential productivity and national income gains. Ø U. S. and foreign tax authorities should recognize that U. S. dominance of e-commerce is transient. Discriminatory application of VAT and other taxes will slow efficiency gains. Ø OECD is seeking to build consensus among member states and developing countries. Ø

25 Tax policy implications Ø Neutral application of tax rules and government regulation is critical Convergence of technologies is causing companies to cross industry boundaries (e. g. , broadcasting over the web) Ø Some products can be supplied in tangible or intangible form (“digital goods”), but government regulations may treat these differently Ø

26 Principles to guide tax policy Ø Commission’s deliberations should be guided by four basic tax policy principles: 1. Neutrality 2. Simplicity 3. Free trade 4. Technological efficiency

27 Principles to guide tax policy 1. Neutrality Ø E-commerce should not be taxed at a higher rate than economically similar transactions conducted through traditional methods. ØAs a corollary, E-commerce transactions should not be subject to special taxes that don’t apply generally. E-commerce should not be held to a higher (and more expensive) standard of compliance than traditional forms of commerce. Ø Tax administrators should respect the privacy of e-commerce transactions to the same extent as traditional commerce. Ø

28 Principles to guide tax policy 2. Simplicity Ø Simplifying current tax systems will ease technological solutions to collecting tax on the net. ØJurisdictions should harmonize the classification of goods and services, within both retail sales and VAT systems, and limit the number of tax rates. Ø The application of current law to e-commerce should be clarified where necessary. Ø Tax authorities should use e-commerce technology to reduce compliance costs.

29 Principles to guide tax policy 3. Free trade E-commerce imports should not be taxed more heavily than similar domestic supplies. Ø Double taxation (by the country of export and the country of import) should be avoided. Ø On-line provision of services and digitized goods should remain duty free. Ø ØConsistent with U. S. policy seeking to reduce tariff and non-tariff barriers to trade. ØConsistent with current tariff schedules and customs procedures that are applicable only to commodities.

30 Principles to guide tax policy 4. Technological efficiency Taxes should not interfere with the development of efficient, market-driven e-commerce technologies and business models. Ø This tax policy strategy will minimize compliance costs and maximize efficiency. Ø

31 Conclusion There is no support for “Chicken Little” claims that the tax system is hemorrhaging as a result of e -commerce. Ø Nor is the healthy development of e-commerce dependent on a perpetual tax moratorium. Ø Rather, the Commission should seek: Ø Ø Neutral taxation of alternative methods of conducting similar transactions. Simplification, so taxes can be collected at reasonable cost from both small and big businesses Utilization of e-commerce technology by tax authorities to lower compliance costs.