Author:	Greg Fitzgerald
Subjects:	Electronic Commerce (Other articles) Electronic Commerce Law and Legislation (Other articles) Taxation Australia (Other articles)
Issue:	Volume 6, Number 3 (September 1999)
Category:	Refereed Articles

Contents

• Introduction
• The Current Electronic Commerce Environment
• Off-Line Transactions
• On-Line Transactions
• Inability to identify a transaction
• Encryption of transaction
• Collecting the tax from millions of end users
• Difficulties in determining where a product has been produced or consumed
• Place of taxation
• The Australian 'Connection Tests'
• Reforming the Place of taxation Rules
• Taxing the value, not the medium
• Type of Service Being Supplied
• Reaping the Benefits of Disorganisation
• Bibliography
• Notes

Links for this article:

• A New Tax System [Goods and Services Tax] Act, 1999 http://www.austlii.edu.au/au/legis/cth/consol_act/antsasta1999402/index.html
• OECD http://www.oecd.org/freedoc.htm

Introduction

1. In 1998 the federal Liberal government was re-elected with a campaign promising to introduce a new tax system into Australia. A major part of this tax system is a broad-based Goods and Services Tax (GST). Out of the 29 OECD countries, Australia will become the 28th country to install a Value Added Tax (VAT). A GST is one form of a VAT, sales tax is another. The VAT to be installed in Australia is, in most respects, the same as the credit invoice tax systems used by all other OECD countries. The main difference is the broad-based Australian system. Following the compromise with the Democrats, the tax will be placed on all goods and services, except basic foods.

2. The Howard government, when campaigning for the election and the tax, professed that it would minimise opportunities for tax avoidance. They professed that by reducing the burden on the income tax system and reforming taxes such as the Fringe Benefits Tax and systems such as partnerships and family trusts, high income earners will be left with less loopholes with which they can evade their taxation obligations. They also professed that by putting in place a broad based VAT the burden will be more equally shared by all classes of taxpayers. This paper will show that the increased use of the Internet to do business will provide the government with a number of problems in making their assertions become reality.

3. Increases in global commerce, global communication and the benefits provided by the Internet are increasingly providing businesses and individuals with opportunities to perform transactions with businesses outside of Australia. The changes in the way we do business will lead to many problems for the Australian Taxation Office (ATO) and other tax administrators around the world. This paper addresses some of the concerns raised by the introduction of a GST into a society that will be using technology to do increasing amounts of business.

   The Current Electronic Commerce Environment

4. At the moment electronic commerce is being led by businesses which are adapting traditional retail transactions to an electronic medium. Businesses such as CD-Now[1] and Amazon.Com[2] are supplying customers with an electronic medium in which to purchase tangible goods, Music CDs and Books respectively. These goods are delivered to the customer via the existing postal system.

5. We are only beginning to see the development of electronic commerce involving digital products. This has been started with the most easily downloaded product, software. It has the possibility of being extended to any other good that can take a digital form. Major goods include: movies, music, books, and information services such as banking, insurance, consulting, etc. The limiting factor, which currently exists, is the limited bandwidth provided by current telecommunications systems. A limited bandwidth means that high speed communications are not possible when dealing with large amounts of information such as a music CD [about 70 megabytes] or large software programs [MS Office is currently about one gigabyte (1000 megabytes), depending on options]. In the future, once separate communications systems are widely used[3] bandwidth will be extended and the downloading of electronic products over the Internet will become an increasing phenomenon.

   Off-Line Transactions

6. The term off-line transaction is used to describe any transaction where goods and services are ordered and possibly paid for electronically, but delivered by other means. As previously stated, the bulk of Internet commerce is currently found in off-line transactions. Contrasted with normal retail transactions, off-line transactions cause disintermediation. "Disintermediation is the elimination of 'middlemen' in the production and distribution chain."[4] This has two key implications. First, 'middlemen' provide the Australian Taxation Office (ATO) with useful tax collecting and data gathering points. "Second, if there are fewer 'middlemen' then tax administrations will be forced to collect smaller tax amounts from a larger number of taxpayers, raising the cost of tax collection."[5]

7. The ATO must levy the tax directly on the consumer itself, or by way of the Customs authorities. Off-line transactions should therefore not provide the ATO with any significant problems in figuring out how to tax them, but will supply the already downsized Customs authorities with substantially increased traffic. The ATO states:

   The enforcement implications of disintermediation are significant. The practicalities of enforcing sales tax, customs duty [and VAT][6] differ considerably between the case of a container load of goods imported via a registered importer/wholesaler on the one hand, and several thousand end users who have ordered goods from overseas websites.[7]

   The tax authorities will need to rethink their current methods of tax collection, simplifying or streamlining procedures without causing revenue and other cross-frontier controls to be threatened.[8]

   On-Line Transactions

8. The term on-line transaction is used to describe any transaction that is delivered on-line (over the Internet). These transactions provide tax authorities with the major headache in collecting the VAT. The problems with on-line transactions, as perceived by tax collecting authorities, include:
   • Inability to identify a transaction,
   • Encryption of transaction,
   • Collecting the tax from millions of end-users rather than a small number of intermediaries,
   • Difficulties in determining where a product is produced or consumed.
   • Definitions of goods and services, and,
   • Distinctions between types of services.

   Inability to identify a transaction

9. Tax-collecting authorities will be virtually powerless in identifying transactions between Australian consumers and overseas suppliers, where all of the transaction has been performed electronically and paid for using either; a credit card from an overseas bank[9] a stored value card or electronic cash ['Internet money'].

   Encryption of transaction

10. Powerful encryption technologies are now available to the everyday Internet user and are expected to become commonly used in the next two or three years. These technologies allow users to encrypt all of a transaction so that only the parties involved can decrypt the information. This means that if the ATO or other tax authority is able to intercept a transaction they will not be able to read it or understand its content in order to identify whether the transaction involves assessable goods or an assessable dealing. The use of encryption technologies will not only be conducted by tax evaders but also by the most honest citizen who just wishes for his/her transaction to be secure.

    Collecting the tax from millions of end users

11. If a tax collecting agency is to find a way around the previous two issues then it will find itself with the problem of having to collect tax from millions of individuals rather than intermediaries. This will significantly increase the cost of tax collection. [This issue has been addressed previously with off-line transactions]

    Difficulties in determining where a product has been produced or consumed

12. Value Added Taxes are usually collected where the consumer is located. The nature of the Internet with its anonymity and lack of paper trails makes it hard and in many cases impossible to determine the physical location of a supplier and consumer.

    Place of taxation

13. The VAT systems currently in place in the 27 OECD countries are credit invoice tax systems. The credit invoice method has a basis that relies on a number of rules. One of these rules is the place of supply rule. This rule determines the country where tax on a transaction is chargeable, to ensure that appropriate goods and services are subject to taxation, but only once. The OECD has recommended that the place of supply rules be called the place of taxation rules so as to minimise "any prospect of misunderstanding about the extent and implications for countries arising from any consensus reached on the place of taxation".[10]

    "The basic rule in the case of goods is the place where the goods are when dispatch or transport begins. The place of [taxation] rules for services are much more complicated and can be either the place where the supplier is situated or the place where the customer is situated depending on the category of the services in question."[11]

14. All of the place of taxation rules currently in existence contain a distinction between goods and services. This was due to the perceived inability for services to be exported. As the nature of services changed and they began to be exported, the place of taxation rules had to develop so as account for these changes. Many of the place of taxation rules that have been developed for services differ depending on what service is being provided.

15. The OECD has summarised the place of taxation rules for services.[12] In the EU the basic rule is the place of taxation being where the supplier has established his business or has a fixed establishment from which the supply is made.[13] This basic rule is subject to a number of exceptions, even in the EU. The place of taxation may be where a service is performed or where intangible property is provided.[14] "In other jurisdictions 'the place of [taxation] is the place of performance of a service'"[15] There are also rules that define the place of taxation as the place of residence of the consumer. Things become rather more complex when the many exceptions are identified.

16. Increases in global communication and commerce have meant that businesses can now perform transactions with consumers in jurisdictions in which the business has no fixed place of establishment. Businesses who wish to minimise their tax obligations can now turn to non-resident suppliers who are in a country which does not impose a VAT.

17. The OECD sub-group on Consumption Tax and Electronic Commerce has identified one of its tasks as being "to reach a consensus that ensures taxation in the place of consumption of a range of services and intangible property, which can be delivered for use and enjoyment outside of the fiscal jurisdiction of the supplier".[16]

    This "[c]onsensus is necessary at an international level if Member countries are to ensure the effective application of consumption tax systems to electronic commerce that:
    a) prevents double and unintentional non-taxation;
    b) protects tax revenue generally;
    c) does not increase the opportunity for tax avoidance, evasion or fraud;
    d) minimises the cost of compliance for business; and,
    e) does not hinder the development of electronic trade."[17]

18. The GST Act passed by the Federal Parliament[18] does not contain the same place of taxation rules as the European Union countries. This could mean that consumers purchasing services from an international service provider may be subject to double taxation. "Double taxation may distort competition against overseas suppliers and threaten the tax base of the country where the consumer belongs. The lack of symmetry in existing tax systems in respect of cross border trade is highlighted by electronic commerce."[19]

    The Australian 'Connection Tests'

19. Section 9-25 of the GST Act, A New Tax System (Goods and Services Tax) Act 1999 (CTH), establishes the connection tests. Particularly relevant are sub-sections 3 and 5. These are:

    SECT 9-25 Supplies connected with Australia Supplies of goods to Australia
    (3) A supply of goods that involves the goods being brought to Australia is connected with Australia if the supplier either:
    (a) imports the goods into Australia; or
    (b) installs or assembles the goods in Australia.

    Supplies of anything else
    (5) A supply of anything other than goods or real property is connected with Australia if either:
    (a) the thing is done in Australia; or
    (b) the supplier makes the supply through an enterprise that the supplier carries on in Australia.

20. Sections 13-5 and 84-5, although not directly related to the connection tests, are also relevant to the issue of place of taxation.

    SECT 13-5 What are taxable importations?
    (1) A taxable importation is an importation of goods into Australia, but only to the extent that it is not a non-taxable importation.
    (2) You make an importation of goods into Australia if:
    

    (a) you enter the goods for home consumption (within the meaning of the Customs Act 1901); and
    (b) at the time they are so entered for home consumption, you are the owner (within the meaning of that Act) of the goods.

    SECT 84-5 Intangible supplies from offshore may be taxable supplies
    (1) A supply of anything other than goods or real property that is a supply not connected with Australia is a taxable supply if:
    

    (a) the recipient of the supply acquires the thing supplied solely or partly for the purpose of an enterprise that the recipient carries on in Australia, but not solely for a creditable purpose; and
    (b) the supply is for consideration; and
    (c) the recipient is registered, or required to be registered.

21. First to look at the issue of goods. Section 9-25(3) requires that for the supply to be connected with Australia the supplier must import the goods to, or install or assemble them in, Australia. Section 13-5 requires that for the importation to be a taxable importation you, being the owner of the goods, must enter the goods for home consumption. An importation of goods can either be an importation that is connected with Australia or a taxable importation. The definition for a taxable importation is much wider as it includes any person regardless on whether they are the supplier or the consumer. The overlap caused by the two definitions is something that would preferably be avoided. In order to avoid any confusion and misinterpretation section 13 should be re-written into section 9, therefore removing the inconsistencies.

22. The issue of services and the supply of other intangible products is much more complicated. Section 9-25[5] requires that for a supply of anything other than goods or real property to be connected with Australia the thing must be done in Australia or it the supply must be made through an enterprise carried on by the supplier in Australia. Section 84-5 extends this definition to included all supplies that are received by a registered recipient and which were acquired for consideration on behalf of an enterprise that the recipient carries on in Australia. Section 9-25[5] does not cover electronic commerce in any form.[20] Section 84-5 extends the definition to cover electronic commerce in certain business to business transactions.

    Reforming the Place of taxation Rules

23. The follow up to the Turku OECD Conference in Ottawa led to some reform in the place of taxation rules. Rule 5 states:

    Rules for the consumption of cross-border trade should result in taxation in the jurisdiction where consumption takes place and an international consensus should be sought on the circumstances under which supplies are held to be consumed in a jurisdiction.[21]

    Rule 6 states:

    For the purpose of consumption taxes, the supply of digitised products should not be treated as a supply of goods.[22]

24. These reforms help to clear up some of the problems created by the place of taxation rules. Rule 6 appears to be straightforward but the question of how to tax goods that can be supplied both digitally and through a tangible medium remains. To tax products differently depending on the medium and method with which they are transported is in this authors view an unacceptable situation and defies the internationally recognised taxation principle of neutrality.

25. The GST Act passed by parliament this year has basically ignored the OECD recommendations as outlined in the Ottawa report. The 'connection tests' themselves are not written in a form that would directly implement the rules of the OECD. Section 13-5 is the only, relevant, section that relates specifically to placing taxation on goods that are consumed in Australia, therefore complying with the OECD recommendations. There is a need for the Australia and other countries to quickly follow the OECD recommendations and implement the rules.

    Taxing the value, not the medium

26. The definition of a good has generally been the definition as stated in the GST Act.[23] Goods are defined as any form of tangible personal property.[24]

27. Although not defined, Intangible Supplies appears to mean "a supply of anything other than goods or real property.[25] Therefore intangible supplies include all services and goods of an intangible nature. The GST Act's definitions are severely lacking in foresight, as they do not recognise the implications of the existing definitions of goods and services. The use of goods and services and tangible and intangible supplies seems to be interchangeable in the act as no clear definitions are provided for any term other than goods.

28. The definition of goods is being attacked in the digital realm. We have seen an increase in the number of intangible commodities. What was once reserved for accounting terms such as goodwill has been expanded in the information society. Intangible products can now take the form of software, newspapers, music, movies, and books, just to name a few.

29. The OECD does not find this situation acceptable and states "that the classification as a good or a service should not depend on the means of distribution (e.g. sale of standard software through a retail outlet versus sale of standard software via direct download)."[26] The OECD seems mystified in its report where it continues:

    However, it is yet less clear how consistent treatment can be achieved. It may well be that the growth of electronic commerce may lead to a reevaluation of the way certain transactions are traditionally classified.[27]

30. This mystification can be attributed to the myopic view taken by tax administrators in the early 60's and beyond, when digital products where first being developed. When software was first made available it was classified as a good as it was thought you could hold onto it. But today everyone knows that you are not holding onto the software you are holding onto the medium in which it is transferred. This view can be extended further to books and newspapers. The information is the important part not the medium in which it is transferred. Another view is to look at where the value lies. A latest release Green Day CD costs $25 US. A blank CD costs $2 US. The value is in the music, not in the medium.

31. Traditionally the two could not be separated. The information needed a tangible medium. This is still the case but the nature of the medium has changed. The medium may now be unrecognisable and indefinable. The taxation authorities made a mistake when they began building the taxation system around the medium and not the product. When the medium changes to something that cannot be taxed the authorities may lose a good proportion of the tax base.

32. A distinction needs to be made between:
    1. Goods that are themselves the medium [eg; food, clothing, cars, etc],
    2. Non-information services [services with the majority of value attributed to the time of people and not to the supply of information]
    3. Goods that require a medium [intangible goods] and information services.

33. Services that fall into the non-information service category would include: much of tourism, hairdressing, telecommunications, banking, bus and taxi services etc. Goods that require a medium, and information services, would include: movies, music, software, photography, etc and consulting, accounting, legal services, education, etc.

34. By moving the tax from the medium to the product will remove the ways around the place of taxation rules. Another method to remove the ways around the place of taxation rules would be to make the rules the same for all goods and services. There is still, however, a need for the definitions of goods and services to be overhauled to take into account the existence of intangible goods and place the relevance on the value not the medium used to transport the value.

    Type of Service Being Supplied[28]

35. Another issue created by the European place of taxation rules is that having different place of taxation rules for different services means that businesses who may provide more than one service in one transaction will tailor the name of the service provided to suit the place of taxation rules so as to minimise tax. New services which do not fit into one of the classifications detailed in the rules may seem to fit in the middle and provide confusion as to which jurisdiction should tax. New combinations of services are also beginning to be offered. Examples are businesses who may provide free Internet access to customers who order goods and services on-line, or who may provide free banking with each Internet connection.

    Reaping the Benefits of Disorganisation

36. This paper has shown the evolving state in which tax authorities currently find themselves when dealing with the questions of how to tax electronic commerce. Scholars and academics are currently being forced to find ways around archaic definitions created by a society that never imagined our current world possible. The tax authorities are currently playing catch up to technologies that are years ahead of them.

37. However, one thing the authorities cannot do is stop and wait. One academic report has posed the question: "When should any actions occur? Technology is still evolving and Internet-related industries are still reshaping/evolving - are we ready to set tax policies yet?"[29] This question is dangerous to pose. It must be realised that the world has sped up and the evolution of technologies will not stop and will not dramatically slow down. We must always be ready to set policies and to adapt and change them if necessary. The days of sticking with the one policy are over. The lack of certainty is something we must get used to.

38. If tax policies do not continue to evolve with the technology we will see gaps become present and problems occur. The possibilities for tax avoidance will increase whenever tax administrators are caught behind. It will always be the large businesses who have the most to gain from the disorganisation of the tax administrators. Thankfully for tax authorities large businesses are also usually slow in their evolution. The day this changes will be the day we all see the tax administrators shed themselves of the red tape that has always slowed down their responses.

Bibliography