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    Journal of Information, Law and Technology

    To Tax or Not to Tax? That is the question?Overview of Options in Consumption Taxation of E-

    Commerce

    Subhajit Basu

    Lecturer Information and Technology LawSchool of Law, Queens University Belfast

    [email protected]

    This is a refereed article published on: 30 April 2004

    Citation: Basu, 'To tax or not to tax? That is the question? Overview of Options inConsumption Taxation of E-Commerce ', 2004 (1) The Journal of Information, Lawand Technology (JILT). .

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    Abstract: Consumption taxation of e-commerce should be consistent with the basicprinciples of international taxation. In order to aid the policy-based discussion inrelation to consumption taxation, this paper provides an outline of thefundamental policy concerns that arise in any thoughtful consideration of

    changes in a system of taxation. The paper explains in broad terms the objectivesand principles that should guide the consumption taxation of e-commerce and itcritically evaluates the different options forwarded primarily by the OECD forcollection of consumption taxes.

    Keywords: E-commerce, Taxation of e-commerce, Consumption taxation,Destination and Origin Principle

    1. Introduction: The Nature of the Debate

    The greatest challenge to a tax regime is its ability to adjust and adapt to a changingworld. The coming of the age of e-commerce, the increased mobility it brings to

    business, and the greater flexibility it offers to the way that transactions andcommunications are made is the latest and perhaps the most demanding of thesechallenges (Deloitte & Touch, 1997) [1] .

    The relationship between taxation and the emergence of the modern state, in short,was one of mutual constitution: taxes made the state, and the state made taxes [2].Given this history, it is not surprising that taxation was, and continues to be, viewedas a central function and prerogative of the state. The study of taxation had beenlargely a parochial issue. It focused, mainly, on national concerns. Globalisationhowever initiated international co-operation and the development of internationaltaxation. However, even when an international perspective has been necessary, suchas when concerning the taxation of truly multinational enterprises, it has usually beenapproached as an aggregation of national perspectives rather than by adopting a trulyinternational one. This history of taxation now raises intriguing questions for the

    present day. Territorial States are not particularly well suited to the task of taxingnon-territorial e-commerce.

    Any serious attempt to examine the legal and policy issues raised by taxation of e-commerce must begin with an understanding of the technological and business

    background out of which they arise [3] . This background has been described clearlyand in detail elsewhere [4] . Even so, it is appropriate to begin this discussion withsome observations about the attributes of e-commerce that have significantimplications for taxation, and the fundamental issues that these attributes pose for taxadministration and also place in context the more technical consumption taxationissues to which most of the paper is devoted. Jeffrey Owens, Head of Fiscal Affairsfor the OECD, back in 1997 identified six characteristics of the Internet that wouldinfluence the operation of tax systems. [5]

    First, the ability of the internet to establish public and private global communicationssystems that are secure and inexpensive to operate. The simplicity and low costassociated with establishing an Internet presence infers that relatively unsophisticatedenterprises can operate a commercial web site.

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    Second, the process of 'disintermediation' whereby the Internet eliminated orsubstantially reduced the need for intermediaries in the sale and delivery of goods andservices, and in the provision of information. E-commerce requires a small number ofdistribution, sales representative, broker, and other professional intermediaries.

    Third, the development of encrypted information, which protects the confidentialityof the information, transmitted on the Internet. Whilst it is possible to detect amessage sent by one person to another over the Internet, encryption generally

    precludes understanding the content of the message.

    Fourth, an increased scope for the integration of business functions, e.g., design andproduction. Private Intranet networks are now widespread in MultinationalCorporations (MNEs). The OECD estimates that at least two-thirds of Internettransactions take this form. This development produces a closer integration oftransactions within an MNE and makes it increasingly difficult to separate out the

    functions carried out by related enterprises. This integration may also produce adramatic synergistic effect--- the sum of the parts being much less than the integratedwhole.

    Fifth, the Internet provides greater flexibility in the choice of the organisational formby which an enterprise carries out its international activities.

    Sixth, the Internet has led to a fragmentation of economic activity. The physicallocation of an activity, whether in terms of the supplier, service provider, or buyer ofgoods or user of the service, becomes less important and it becomes more difficult todetermine where an activity is carried out. [6]

    Owens also points out that there are several technical features of Internet and intranetsystems that are likely to have significant impacts on the operations of tax systems,namely, the lack of any central control; the lack of central registration; the difficultyif not impossibility of tracing transactions; and the weak correspondence between acomputer domain name (i.e., an Internet address) and reality (i.e., the actualgeographic location of the addressee or the computer equipment used to transmit orreceive the information). Owens observations remain as true today as they werewhen he made them six years ago, even though 1997 may seem like the Dark Ages

    by the standards of Internet time. One does not have to be a tax expert to discern thebroad implications of the foregoing developments for territorially based taxing

    regimes [7] . First, there is the sheer magnitude of the increase in cross-bordertransactions. Second, to deter evasion, it is the responsibility of tax authorities tomonitor economic activities. However, given the decentralized structure, the varietyof transmission media, the binary format, and the various encryption and securitymeasures, the tax authorities ability to monitor economic activity-involving e-commerce is impaired. Further, tax collection in the digital environment poses anumber of problems including:

    The determination of the type of tax to be collected

    The ability of the vendor to collect the tax

    Determining the jurisdiction in which tax should apply

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    Verifying the place of consumption

    Determining the correct tax treatment of bundled products, bad debts, and tax credits

    Retaining data

    Complying with audit requirements [8]

    While the evolution of e-commerce raises these issues in regards to the application oftraditional consumption tax rules in each of these above stated areas, all of theseissues are compounded by the potential for different implementing legislation inindividual countries. In some instances, the potential for multiple laws addressingidentical issues in different ways might be as challenging as finding any single way toaddress the underlying issue. In addition to creating high compliance costs forgovernments and suppliers, the implementation of inconsistent laws and definitions

    possibly will result in double taxation or unintentional non-taxation of e-commercetransactions [9] . Hence, from the standpoint of tax administration, the principalchallenge remains how to implement geographically limited taxing systems in atechnological environment that renders geographical borders essentially irrelevant.

    The debate on taxing e-commerce has initially been focused on tangible products soldto businesses and consumers, which is not surprising given these transactions accountfor the largest percentage of e-commerce sales. However, this trade does not raise anyfundamental taxation issues, because the proper destination-based consumption taxcan be levied once the consignment passes through customs. However, if both the

    payment method and product is digitizedfor example, downloaded software paid

    for with electronic cashvast tax enforcement issues arise because the origin anddestination of these transactions is obscured. To be able to effectively tax aconsumption transaction under traditional taxation principles, tax collectors need toknow where the transaction takes place and whether the transaction involves a goodor service. Sellers of intangibles often do not knowand typically do not have a needto knowthe physical location of their customers. Indeed, the anonymity of theInternet makes it very easy for customers to hide their identity and physical locationfor tax evasion and privacy reasons. Moreover, it may be difficult for the taxauthorities to determine the location of the vendor, who typically collects theconsumption taxes. For example, the vendor may sell its products using a Website ona server located in another country or jurisdiction. Accordingly, the point of origin

    and destination of transactions is obscured, making it hard to enforce fiscal frontiers.The crux of the problem is that the Internet and new communication technologieshave introduced the new channel through which sales occur. It is a matter of debate,however, as to whether these new channels create new products. Some believe thatdelivery through these channels alters the character of a product to such a degree thatit should be considered as wholly new product, distinguishable from that deliveredthrough traditional channels, and therefore treated as unique for tax purposes. Others

    believe that digitising a product does not alter the purpose of the product andtherefore the digitised version should be treated the same for tax purposes as thatdelivered in physical form. Typically, countries apply differential tax rates to goodsand services, which necessitates a clear classification of digital products as one or the

    other. A key question is then whether a downloaded movie is functionally the sameproduct as a rented movie. In addition, tax administrators rely on following a 'paper

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    trail' of transactions for auditing purposes, whereas digital transactions typically donot generate such records. Can and should these transactions be taxed? [10] Thedebate on the effective taxation of e-commerce has yielded a number of proposals ontax collection models, ranging from the traditional vendor collection model to modelsemploying third parties, some of which are reviewed in this paper. This paper also

    attempts to provide an answer to the principle question: What kind of taxing regimewould allow participants in e-commerce to pay and collect taxes in anadministratively feasible fashion to those states with a legitimate claim on taxrevenues?

    2. Principles for a New Tax

    The principle difficulty in developing an e-commerce taxing regime for consumptiontaxes is that the Internet is still a new medium whose full ramifications are not closeto being understood. However, concerning tax policy it is believed that while it may

    be necessary to modifythe tax systems of both States and Local governments to

    accommodate e-commerce, the basic contours of taxation are not likely to changedramatically; neither the composition nor the nature of taxation is likely to changefundamentally.The OECDs work on consumption taxes, which is firmly based on theTaxation Framework Conditions, expresses similar views. In this context, it is worthrecalling the most relevant emerging conclusions of these conditions:

    First, the taxation principles that guide governments in relation to conventionalcommerce should also guide them in relation to e-commerce. In other words, no newtaxes should be introduced exclusively for e-commerce.

    Second, existing taxation rules must be used to implement these principles.

    Third, the process of implementing these principles should involve an intensifieddialogue with business and with non-member economies.

    In addition to these conditions the OECD identifies a number of Taxation Principles.The most relevant for collecting Consumption Taxes are:

    First, efficiency Compliance costs for taxpayers and administrative costs for the taxauthorities should be minimised as far as possible.

    Second, neutrality, certainty, and simplicity. The tax rules should be clear and

    simple to understand so that taxpayers can anticipate the tax consequences in advanceof a transaction. This includes knowing when, where and how the tax is to beaccounted. Simplicity often conflicts with other important objectives of tax policy;where this is true, it is necessary to make trade-offs between simplicity and otherobjectives.

    However, in spite of these international agreements, the taxation of e-commerce is noless chaotic now than it was 3 to 4 years ago when the negotiations were first started.One contributing factor is the resistance of taxpayers towards the payment of taxesand their effort to structure their affairs in order to minimize taxes payable. A secondfactor is the desire of cash-starved nations to maximize tax revenues. Together, these

    factors pose challenges and opportunities for both taxpayers and the tax authorities intheir approach to the taxation of e-commerce.

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    McLure (1997) argues that there should be few further principles to guide thedeliberations in the area of tax policy. First, and most obviously, it will be importantto avoid distorting choices of how to satisfy a given need, taxation rates should notdiffer, depending on the technology and commercial channels used to satisfy needs. It

    should treat all commerce equally. It should not discriminate in favour of or against e-commerce; nor should it distinguish between types of products (tangible, intangible,or services) or income from them. For example, taxation should not distort the choiceof how to provide the following products: music (tapes or compact disks vs.downloaded from the Internet), movies (video cassettes vs. downloaded), and readingmaterials (printed books, magazines, and newspapers vs. downloaded). Second, it will

    be important not to distort the choice of technology used to provide particularintangible products and services: for example, the provision of television signals overthe air using traditional broadcast technology, via cable using wires (provided byeither cable companies or public utilities) and fibre optic cables, or via directtransmission to satellite dishes. Third, taxation should not affect the choices of

    whether and how to 'bundle' various goods and services for purposes of pricing. Thismeans that there should be neutrality towards bundling. For example, whether toinclude software on compact disks sold with books and whether to use lump-sum

    prices or itemized charges for basic and enhanced telecommunications and for theservices of ISPs and OSPs, including, especially, the bundling of content and Internetaccess. Fourth, taxation should not distort location decisions or trade between

    jurisdictions and should neither favour nor penalize local producers and distributors.This has several dimensions, including avoidance of tax-induced distortions ofcompetition in the provision of tangible products, intangible products, and services.Location distortions may have either interstate or international dimensions [11] .Further, from a tax administration point of view (and compliance), any taxing scheme

    should be made relatively easy.

    The challenge for policy makers is to respond accordingly to these principles whilstalso ensuring that needed government expenditures are funded and that tax distortionsare minimised. A significant part of this response will necessarily involve greaterinternational co-operation. This international cooperation must also extend beyond

    bilateral treaties and even beyond multilateral agreements between signatories toplay by the rules. It must include the possibility of sanctions against nations that

    provide a hospitable setting for those who desire to operate in a sheltered environmentin order to avoid taxes on their sales and income. It should be noted here that this isnot an attempt to stall economic progress by protecting prior technology from the

    onslaught of new technology. However, nor is it a plea to penalize prior technologyby giving new technology tax breaks.

    The principle objective in designing taxation for e-commerce is achieving neutrality.Neutrality avoids distortion in choices involving consumption, production, location,or methods of finance [12] . Neutrality is especially important in the taxation of e-commerce because of the ease with which transactions can be diverted in response todifferential taxation, for example, to seemingly different products that satisfy thesame underlying needs, to quite similar products that are delivered through differentdistribution channels, or to sources located elsewhere. How to achieve economicneutrality in VAT and Sales tax involving cross-border sales? An economically

    neutral sales tax will apply a single rate to all consumption occurring within a givenjurisdiction, but not to business purchases or to exports [13] . This is true whether a

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    given product is tangible or intangible or a service and whether it is produceddomestically or imported. In principle, VAT produces this result automatically, since

    both imports and domestically produced products are subject to tax, exports are zero-rated, and business taxpayers are allowed a credit against tax liability on sales forVAT paid on purchases. While full competitive neutrality is achieved with respect to

    the supply of services by EU suppliers to non-EU customers, non-EU suppliers arenot required to charge VAT when they supply services to EU customers, causingcompetitive disadvantage. However, in response to this the EU Commission amendedthe VAT Directive and EU suppliers are no longer required to charge VAT on onlinetransactions involving non-EU customers, ensuring competitive neutrality withrespect to EU exports to non-EU countries and VAT treatment of non-EU suppliers.EU taxable persons are now taxed according to destination based taxation.

    McLure also argues [14] that in theory it will be much more difficult to achieve aneutral sales tax than to achieve a neutral VAT. He also argues that it will be equallydifficult to eliminate two of the most glaring defects of state sales taxes in the US, the

    bright-line physical presence test for the use tax nexus and the exemption (ordifferential treatment) of intangible products and many services, though changes havelong been high on the tax reform agenda in this area. But in order to do so, greateruniformity of state laws, simplified administrative procedures, rationalizing nexusrules as well as unifying the tax treatment of tangible and intangible products andservices will be required. Otherwise, it will create an unacceptable burden ofcompliance, especially on small business firms making interstate sales, and aggravatethe problem of pyramiding the collection of tax on both business inputs and sales tofinal consumers.

    In order to implement the solution in the context of the sales tax, it will be necessary

    to distinguish between sales to businesses and sales to households; the former shouldbe exempt, even if the later are taxed. This problem is ordinarily addressed byexempting certain goods (essentially those that are unlikely to be bought byhouseholds) and by allowing firms to buy on a tax-exempt basis. It is useful to askhere: Do households or business firms derive the most benefit from governmentservices? To the extent that public services are provided primarily to households andare complementary to private consumption, it would be appropriate to levy a tax onconsumption (as under a destination-based VAT or an ideal sales tax) as a quasi-

    benefit tax; to the extent that they are provided primarily to business and arecomplementary to production, a production-based tax (such as an origin-based VAT)would be more appropriate. While there is no easy answer to the question, a

    consumption-based tax levied under the destination principle would be be moreappropriate. Tax should be applied to all sales to consumers in a given State; mail-order sales and their tangible and intangible counterparts in e-commerce should not

    be exempt just because vendors lack a physical presence in the State.

    Hence, the basic incompatibility of the sales tax system with the VAT system remainsas the major unsolved tax problem. So far, most countries and internationalorganisations have shied away from a radical solution to this problem alleging it isimpractical to implement. However, with the continuing growth in e-commerce, thiscautious position will ultimately have to be reconsidered by the OECD and theinternational community. The OECD's development of guiding principles for a

    framework to tax international e-commerce transactions, including a desire to usetraditional international tax principles that promote neutral treatment between

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    physical commerce and e-commerce, low compliance costs, and flexible rules to keeppace with technological developments [15] is considered as positive step in the rightdirection. Indeed developments in technology will be indispensable at least forcollection of consumption taxes on e-commerce to provide an automated tax chargingand collection mechanism towards formulation of system that is technically feasible,

    efficient, and cost-effective.

    3. 'To Tax or Not to Tax'

    The debate over whether to tax or not to tax e-commerce has to be based on fourunderstandings/realizations. First, it may not be easy to achieve the objective ofapplying existing taxes to e-commerce. It may be necessary to rethink how some lawscould be applied to make them suitable for the world of e-commerce. Second, somecurrent tax laws, especially at the state level (US), make no sense; such featuresincludenexus rules, especially as applied to mail order sales, the failure to tax salesof tangible products, intangible products, and services equally,and the application of

    sales taxes to many business purchases. Defects that were already troubling are nowbecoming increasingly untenable and require fundamental restructuring. Third, tosolve either of these problems will also require substantial cooperation between

    jurisdictions, which can be states (in case of a federal system like US) or nations;unilateral solutions are not likely to be satisfactory. Finally, the 'no taxes' option islittle more than a temporary fix, one which overlooks many of the incrediblyimportant longer-term effects of not taxing e-commerce.

    The question of whether e-commerce must be taxed to level the playing field betweene-commerce and conventional commerce has been addressed in several other studies,

    but with mixed results [16] . Those who favour taxation argue that exemptions for e-

    commerce, combined with current taxation systems, will lead to significantdistortions that will put conventional retailers at a great disadvantage. Others claimthat the tax differential would merely inspire conventional retailers to migrate to theInternet and that if state governments are genuinely concerned about equity theyshould consider harmonizing tax rates downward for local retailers, rather thanimposing taxes on e-commerce to eliminate the tax differences. McLure (1999)compares e-commerce events to the history of mail-order catalogues and argues thate-commerce should be taxed [17] . He claims that policies based on the argument thatthere should be a moratorium on e-commerce taxation until e-commerce is matureenough will inevitably keep favoured industries from ever growing up.

    The proponents of the infant industry argument favour no taxes whatsoever on e-commerce.They justify their position by claiming that preferential treatment is a wayto stimulate the development of e-commerce [18] . In support of their position theycite the empirical work of Austan Goolsbee on the possible effects of imposing salestaxes and compliance costs on the Internet. Goolsbee (2000) [19] attempted todetermine the price elasticity of demand associated with e-commerce sales and thesales and consumption choices that would follow from such taxes. Drawing upon datafrom a survey conducted by Forrester Research in late 1997, Goolsbee examined thedemographic traits, residential characteristics, including local sales tax rates, and

    purchasing decisions of 25,000 users. His primary objectives were to determine howlocal sales tax rates affected each individuals choice to purchase something online

    and how they affected the advantage amount of money spent online by the typicalconsumer. Goolsbee found that the coefficient on local tax rates was positive and

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    significant, implying the higher the local sales tax rate, the greater the amount ofmoney the average consumer would spend online. However, Goolsbees findings arenot without their limitations. To begin with the growth of e-commerce has explodedsince 1997. Moreover, it is conceivable that Goolsbees study suffered from aselection bias in that a majority of the consumers in the sample were more

    technologically sophisticated and tax sensitive than the typical offline consumer.Those who are opposed to imposing taxes on e-commerce also cite the growthenhancing effects of the 'network externalities' associated with Internet use; a persons

    joining the network makes it larger, benefiting not only that person, but also the otherparticipants. For example, the value of e-mail increases with the number ofindividuals who also have e-mail and thus are potential exchangers of e-mailmessages. Individual users do not internalize these spillovers. As a result, too few

    people are using the Internet if the government does not subsidize access. Thesenetwork externalities mainly exist in the early stages of a networks development.

    Preferential treatment of e-commerce based on network externalities is not desirable.

    The Congressional Budget Office [20] argues that already a substantial share of theU.S. population (56 percent in 2001) is using the Internet. Moreover, exempting salesover the Internetand thus effectively subsidizing this tradeis an indirect way and

    blunt instrument to address an existing distortion. As the principle of targeting [21]suggests, a distortion should be countered directly at the relevant margin. A morecarefully targeted instrument would be the subsidization of Internet access fees, but inthe US and many other countries preferential treatment of Internet access alreadyexists. Finally, Zodrow (2003) [22] concludes that there is no convincing directempirical evidence available that shows that these network externalities aresignificant.

    On the other hand, the proponents of taxing e-commerce point to the revenue lossesassociated with permanently exempting e-commerce. For instance, Bruce and Fox(2001) estimate that in 2001 e-commerce caused a total state and local governmentrevenue loss of $13.3 billion. They predict that by 2006 this loss will more than tripleto $45.2 billion, reaching as high as $54.8 billion by 2011 [23] .Perhaps this is whyTanzi [24] speaks of e-commerce transactions as rapacious 'fiscal termites' that eataway the consumption tax base. It is not only consumption tax revenues that are atstake here. Some countries levy customs duties on physical trade in digital media,which would be lost if these products were 'imported' electronically. Perez-Esteve andSchuknecht [25] argue, however, that the potential tariff revenue losses would besmall. Nevertheless, it is the governments of developing countries depending heavily

    upon import duties who would be hurt the most. Consumers in these countries,however, would benefit from lower consumer prices for digital products. There isbroad support in the WTO to exempt electronically delivered products from customsduties, thus it is no longer an issue for debate. The rationale is that import tariffscause larger by-product distortions than consumption taxes. Moreover, it would notmake sense to levy these duties if there is no fiscal border.

    Exempting e-commerce sales thus distorts consumer behaviour and thereby createsefficiency losses. Moreover, firms will be encouraged to offer their products onlinewhere otherwise they would have established a physical shop. Given that elasticity ofsubstitution between Web-based and main street purchases of the same good is quite

    high, optimal taxation theory prescribes that charging a uniform tax on traditional andelectronic commerce would minimize efficiency losses. Remote sellers, however,

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    point to the shipping and handling fees on Web-based trade that would offset any taxadvantages that they currently enjoy. This may be true for low-value purchases suchas CDs, but if it concerns more expensive items, such as DVD players and computers,consumers tend to buy from retailers not charging sales tax. Moreover, there are noshipping and handling fees on digital content.

    However, the price benefits that online purchases are facilitating are not available toall. After analysing several surveys across a number of countries, the OECDconcluded that: 'One consistent finding across many countries is that there is a strong

    positive correlation between the use of information technology (PC ownership, accessto the Internet) and household income: for every $10 000 increase in householdincome, the percentage of homes owing a computer increases by seven points'[26].US demographic figures from the Ernst and Young [27] report cited above indicatethat while 53% of households have PCs, only 34% are online and only 17% haveshopped online. Those online buyers had a weighted average annual income of $59000, clearly indicating that online shopping is not available to all. Many families

    today simply cannot afford to purchase a computer. This situation is unlikely tochange in the near term. Similar demographic figures can be found in all countriesthat have been part of or have experienced the growth of e-commerce. If similarstudies were carried out in developing countries, the disparities would be morestriking.

    The incredible growth in e-commerce has also witnessed the creation of a smallnumber of brands that have become global leaders in the marketing and distributionof their products through the Internet. The worlds most popular e-tailer isAmazon.com. Though largely associated with its beginnings as a pure online

    bookseller, its success and business model have expanded considerably. The market

    leadership and consumer acceptance of Amazon.com is also evident in other marketsegments with e-tailers such as Cdnow (for music) and eBay (for auctions). TheseInternet companies have used their high market values to eliminate their competitorsand to take over other companies with high market shares [28] . The January 2000announcement of the merger of America Online, Time Warner and EMI is anexample of such an acquisition. So too is eBay's takeover of Butterfield & Butterfield(the 134-year-old San Francisco auction house) and Kruse International (the upscalecar auctioneer) in 1999.

    Although the OECD has noted the prevalence of similar alliances and acquisitions ininternational markets [29] a survey by Ernst and Young in 2000 showed that only

    10% of etailers indicated that the acquisition of other businesses is part of theirgrowth strategy [30] . Of more concern to traditional retailers are the recent findingsof Jupiter Communications, whose research indicates that the growth in e-commercehas been at the expense of traditional sales [31] . Jupiter found that only 6.0% of

    business-to-consumer Internet sales in 1999 were incremental sales, predicting thisfigure would increase to 6.5% for Internet sales in 2002. Their data indicated that94% of Internet sales were sales that traditional retailers would have expected tomake. While some proportion of these sales would have been facilitated by theInternet operations of traditional retailers, the fact remains that most of the sales ofthe pure Internet e-tailers were sales poached from traditional retailers. Thecontinuation of the preferential taxation treatment of e-commerce will continue to

    exacerbate the sales losses of traditional businesses as the e-tailers exploit their unfairadvantage. It is expected that this may result in the forced closure of many traditional

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    businesses offering services to local and remote communities. How will the localbookstore compete against the purchasing power of companies such as Amazon.comand Barnes and Noble when the purchasing power of these companies is also backed

    by a tax-advantaged position for their Internet sales?

    Hence, taxation should seek to be neutral and equitable between forms of e-commerceand between conventional and e-commerce. Taxpayers in similar situations carryingout similar transactions should be subject to similar levels of taxation. Proposals tomake the Internet a consumption tax-free zone are attractive, but they will have

    potentially devastating economic, tax, and social consequences. For instance, makingthe Internet a consumption tax-free zone would distort several dimensions ofconsumer and business choices: in favour of content delivered on-line, instead of intangible forms, and in favour of products that could be delivered on-line as electroniccontent, relative to products that could not be (notably tangible products and servicesthat cannot be delivered in this manner). Although it would help avoid some of the

    problems otherwise created by bundling, it would also pose formidable problems of

    classification, especially regarding the need to distinguish betweentelecommunications (presumably taxable) and Internet access. Moreover, equitably,

    both horizontally and vertically, it is grossly unfair . Particularly pernicious is theeffect it will have on undermining local retail stores. By exempting a large andgrowing fraction of consumer purchases, this policy will require higher tax rates toraise a given amount of revenue. Finally, it will do nothing to remedy the problems ofthe existing system.

    If preferential tax treatment continues with e-commerce and higher income earnersare able to benefit from buying goods cheaper online through a distribution networknot available to many lower income families, we also run the risk of further widening

    the digital divide. It is hard to justify why this inequity should be further subsidisedby the non-application of sales/use taxes and VAT to e-commerce. It is alsoenlightening in this regard to look at what consumers are buying online. In order ofmost popular Internet purchases, consumers are buying computers, books, CDs,electronics, and toys. Given the demographics of online buyers outlined above theseconsumer items are not those that inherently need Government subsidisation.

    Usage of the Internet and e-commerce is growing most quickly amongst those insociety who can afford access and who have the purchasing power to enjoy the

    benefits it is providing. To minimise the adverse effects this growth is having onsociety, the current inequity in treatment between the distribution of goods and

    services purchased from traditional sources and those purchased over the Internetshould be removed. In summary, taxing all e-commerce will perpetuate or aggravatecompliance and administrative problems. However, exempting it will create inequitiesand distortions and will also aggravate existing problems of classification andcompound discrimination. So the question now is if e-commerce should be taxed,how should it be effectively taxed?

    3.1 Destination or Origin Based Taxation

    Consumption taxes are designed with the basic assumption that the seller and thebuyer are located within the same taxing jurisdiction or at least within compatible

    trading systems. The collection and payment burden is placed upon the buyer, usuallythe retailer, while the economic cost is usually placed upon the consumer. The

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    problem arises in relation to cross-jurisdictional sales where the source country differsfrom the destination country. Hence, cross-jurisdictional sales can be taxed based oneither their destination (that is buyers domicile) or their origin (that is, the sellershome state or country). The e-commerce debate has unfolded against the backgroundof a consumption tax system that is largely based on destination principle.

    Under the destination principle, exports are exempt from consumption taxforexample, a VAT or sales taxand are subsequently taxed at the rate levied by theimporting country, resulting in taxation at the place of consumption [32] . Moreover,tax revenue accrues to the country where the final sale occurs. In a world of perfectcompetition, the destination principle implies that all firms receive the same tax-exclusive price from selling in any location irrespective of their country of residence.This leads to production efficiency in the sense of Diamond and Mirrlees [33]

    because producers equate their marginal costs to a common producer price. Thedestination principle is considered to generate a fair distribution of the tax burden: the

    private consumption base is viewed as a much better proxy for the benefits of public

    goods than other tax bases such as production.

    Various authors such as Fox and Murray [34] and McLure [35] and organisationssuch as the OECD [36] and the European Commission have proposed taxation at the

    place of consumption by means of destination-based registration by vendors. In thiscontext, McLure [37] proposes a complete overhaul of the current U.S. sales taxsystem with a view to simplifying vendors compliance and tax administrationconsiderably. His proposal consists of the following elements: (i) a single uniform tax

    base for all states including conventional commerce, services, and intangibles; (ii) anexemption for all business purchases and those merchants whose sales to consumersdo not exceed a certain threshold or de minimis amount; (iii) the requirement for

    vendors to register and file with their 'base' state (where it has a physical presence inthe form of personnel and warehouses) only; and (iv) a uniform legal framework.Although states under his proposal are to be left free to set their own tax rates, it will

    be politically difficult to implement a uniform tax base in he United States as this willundermine the fiscal sovereignty of local governments.

    The application of destination-based registration at a global level would yield aninsurmountable compliance burden to globally operating firms in a world of morethan 100 different VAT systems. Doernberg and Hinnekens [38] argue that tofacilitate the process of destination-based registration a real-time online systemshould be provided where non-resident vendors can check the validity of VAT tax

    registration numbers of purchasers. Substantial international coordination betweencountries would be required not only to prevent blocs of countries from implementingmutually inconsistent tax policies (potentially giving rise to double or no taxation oftrade flows) and but also to provide for mutual enforcement of tax debts.

    Destination-based taxation has several conceptual advantages. Firstly, destination-based taxation is much less likely to distort the location of economic activity thanorigin-based taxation. Second, taxation of consumption is probably a better proxy forthe benefits of public services than taxation of production. Perhaps most important isthe political attraction of the destination principle. It is not difficult to understand whythose producing for the domestic market would not quietly accept origin-based

    taxation, as it would imply that they would have to pay taxes while their foreigncompetition would not. Under the destination principle market jurisdictions would

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    collect the same tax on domestic and foreign production. Similarly, exporters wouldnot likely take kindly to a suggestion that exports should be taxed. It is relativelyeasy, ignoring legal obstacles for the moment, to collect destination based taxes ontangible products. Where there are fiscal borders, as between nations that are notmembers of a common market, tax can be collected at the border. Within a common

    market, it may be possible for vendors to collect tax because they know where theyship goods. However, the increasingly important technological shift from the

    production and sale of physical to digital products will render destination-basedtaxation difficult to implement. In contrast to products traditionally sold in shops andin a format that gives them some physical content, digital goods do not have physicalcharacteristics. Consequently, it is difficult to determine the location of purchasers.By comparison, origin-based taxation would be relatively easy to implement in thiscase.

    In VAT and sales tax systems the destination model predominates, the idea being thatconsumption is the appropriate subject of taxation and the country in which goods are

    received receives the revenue generated by that consumption. This however hascreated a tax problem, which is also economically disruptive in two particular ways:

    The source country has the ability to enforce compliance but no revenue interest indoing so. On the other hand, the destination country has a revenue interest inenforcing compliance but has difficulty with enforcement, especially in relation tonon-corporeal goods such as digital products purchased over the Internet.

    The source country saves money on enforcement and at the same time enjoysrevenue gains in areas such as income taxes and property taxes. Thus businesseswithin such jurisdictions enjoy competitive tax advantages.

    Further more, since destination-based taxation compels sellers to calculate report andremit consumption taxes for each jurisdiction in which the sales occur, it generatesextravagant compliance costs, especially for small and medium sized firms. Evenwith the best intention and the best tax software, companies find it difficult todetermine their tax remittance obligations in thousands of jurisdictions with differentand constantly changing tax rates, definitions, and reporting requirements. Taxauthorities, for their part, confront a regime of daunting administrative complexity. Adestination system also requires a high degree of intergovernmental cooperation, asthe imposition and enforcement of tax collection obligations on sellers who conducttheir business abroad often requires their home governments consent and

    cooperation. The only equilibrium point under a destination-based regime, moreover,is perfect collusion among all governments. A government that withholds its consenteffectively places its domestic firms beyond the reach of foreign tax collectors and inthat manner hands them a competitive advantage.

    Will origin-based taxation solve these problems? While no solution is perfect andeach solution creates new issues, origin- based taxation seems to answer the major

    problems posed by destination-based taxation and it is relatively easy for the States toimplement. By this system, sales tax or VAT is collected by the seller only at the

    point of origin of the e-commerce sale, which is defined as the sellers physicallocation. This eliminates sellers' concerns over nexus uncertainties, analysis of

    whether items are taxable or exempt in the various jurisdictions, privacy concerns,and the costs of collection and remittance to hundreds, if not thousands, of

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    jurisdictions. Effectively, the major concerns raised by destination-based taxationwould be answered.

    Some scholars in the USA add that origin-based taxation also appears to solve mostof compliance complexities associated with US sale/use taxes. Under this system the

    e-commerce seller is required to collect all the state and local taxes in the jurisdictionwhere the 'principal place of business' of the e-commerce seller is located, regardlessof where the product is shipped or the service performed. The seller's sales are subjectto one-tax rate and one jurisdiction's tax laws and regulations. The tax revenue thusgenerated is allocated according to the laws of the state where the vendor's principal

    place of business is located. This minimizes the burden on the seller in a number ofways. Another positive aspect is that the buyer's 'use tax' liability is statutorilyextinguished even where his or her home state imposes a higher tax rate.

    Because the e-commerce vendor is physically located in the state asserting taxingjurisdiction, there would be no question that nexus exists. Actual physical presence

    will satisfy due process nexus concerns as well as the substantial nexus requirementsof the US Supreme Court. Another potential positive impact of origin-based taxingwould be the maximizing of revenue collected. Because nexus considerations areeliminated, it is reasonable to assume that many transactions that currently escapetaxation would now be taxed. In addition, because it is easy to administer and enforce

    by the taxing officials of the state in which the seller is located, non-compliance willbe greatly reduced. Finally, because the sale is taking place in one location, localtaxes imposed in that jurisdiction will also be collected, eliminating the need for auniform state tax rate, which many states might be legally or politically precludedfrom providing.

    However, some commentators see this as a serious invasion of the purchaser's privacyas it will require the seller to obtain information from the purchaser and deliver thatinformation directly to tax officials. It will be an intrusion that will be unique to e-commerce purchasers because such information is generally not taken from traditional'bricks and mortar' buyers. Because under an origin-based proposal the purchaser will

    be treated the same for tax purposes as a customer who walked into the vendor's store,there will be no need for inquiry into the identity or location of the buyer. Furtherorigin-based taxation will maintain the autonomy of local governments and otherlocal taxing jurisdictions that are strongly opposed to the one-tax-rate-per state idea(this is particularly important for US state and local governments). This will be both

    politically realistic and will respect the notion of federalism, that is, that the federal

    government should not overly intervene in the taxing prerogatives of the states.

    Under a destination-based VAT, tax is applied to goods imported into the taxingjurisdiction and exports from the jurisdiction occur tax-free. Under an origin-basedVAT, exports are subject to tax, and tax is applied only to the value that is added afterimportation. Under this proposal, as with brick and mortar retailers, the buyer isviewed as visiting the sellers location, rather than the seller visiting the buyerslocation. For example, if an online software company in the United Kingdomuploaded a game to a customer in the USA (say Oregon) the software company will

    be liable for the VAT. The same would be true if the software were uploaded to acustomer in London, Moscow, or an airplane crossing the Atlantic. Under an origin-

    based tax system, taxes are collected on all sales out of the relevant tax jurisdiction,and no businesses are being expected to collect taxes for a government from which

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    they derive no benefits. Whether or not the digitised sale is taxable is to bedetermined by the sellers state just as when a buyer physically enters a state to makea purchase. Since businesses are subject to audit, the expected compliance rate withorigin-based tax rules is also very high. Mechanisms to enforce compliance withdomestic consumption tax collection responsibilities are already in place, so a move

    to origin-based taxation would place no additional burdens on businesses and little (ifany) new burdens on national tax administrations. A final benefit of origin-basedtaxation, although most governments do not see it that way, is that such a systemfosters robust tax competition between states. Critics of origin-based taxation oftenwarn that such tax competition will not be healthy, but rather will be a race to the

    bottom for nations, undermining their ability to raise revenue. [39]

    It is also argued that origin-based taxation will disadvantage domestic producers ontheir export sales. Although the design of a nations tax system can effect exportcompetitiveness, the true burden facing domestic producers is the overall level oftaxation. Thus, businesses subject to VAT collection responsibilities may not suffer

    any competitive disadvantages under an origin-based system if tax rates are kept atreasonable levels. A Deloitte & Touch paper put it this way:

    A consumption tax without border tax adjustments (an origin-principle consumptiontax) at first appears to create a disadvantage for domestic producers relative toforeign producers in overseas markets. Border tax adjustments, though, may not bethe only mechanism operating to maintain neutrality. Other self-executingadjustments by the markets, such as reductions in wage rates or in the value of thedomestic currency, could offset wholly any potentially detrimental trade effects oforigin-based taxation on exported goods. [40]

    The European Commission has recognized the inherent benefits of origin-basedconsumption taxes, albeit only on an internal basis. In its 1996 work program for thegradual introduction of a new common VAT system, the Commission announced itsintention to advocate a switch from taxation at destination to taxation at origin forsales within Europe. The changes being contemplated are minor. All transactionsgiving rise to consumption in the EU, a Commission paper states, would be taxedfrom their point of origin so that the existing remission/taxation mechanism for trade

    between Member States would be abolished [41] .

    However, switching to origin-based taxation will shift substantial amounts of tax basefrom developing countries to developed countries where digital contents originates,

    particularly to the US. (In essence, for B2B transactions the origin principle istantamount to exempting the tax free imported component of final products from tax.)There is also a further argument that countries of origin are quite likely to tax digitalcontent preferentially, in order to prevent its providers from locating elsewhere. Thisimplies that digital content will have a substantial competitive advantage over non-digital equivalents, which are taxed under the destination principle. This will createfurther downward pressure on the tax base of developing countries.

    Destination-based taxation is the international norm and is supported by the OECD,EU, and WTO. In practice, the origin principle is hardly applied to trade, except fortrade among the former members of the Soviet Union. Theoretically, as argued by

    Lockwood [42] , the case for preferring destination-based over origin-based taxationbased on efficiency grounds is strong, but not absolute. The modest theoretical case

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    for the destination principle rests on its perceived neutrality: since as taxes areidentical for all sales in a given jurisdiction, sellers have no incentive to locate in alow tax jurisdiction. Under an origin-based system, in contrast, jurisdictionalvariations with respect to both tax base and the tax rate at the margin will inducesellers to locate in low tax jurisdictions. For this reason destination-based taxation is

    attractive and origin based taxation is anathema to tax theorists who place a highpremium on locational neutrality, a notion that holds that the tax system should notunduly distort private economic decisions. However, as explained previously in this

    paper, tax neutrality also requires a single, centrally determined tax rate and base,something which is not a serious political option internationally, although it isdiscussed widely. Only under very restrictive assumptions, typically not met in

    practice, are the two principles equal. First, within each country the consumption taxrate should be the same for all commodities, though that uniform rate may differacross countries. Uniformity implies that relative producer prices are equated torelative consumer prices in each country. Second, bilateral goods trade betweencountries should be balanced [43] , so that a change from taxing imports to exports

    would not have a significant revenue effect. Nonetheless, internationally a largemajority of governments have insisted on extending the destination principle to e-commerce taxation. Thus, the task is to make destination-based taxation 'work' for e-commerce, principally through tax simplification and technological innovation and,foremost, through enhanced intergovernmental cooperation.

    3.2 Bit Tax

    A number of alternative approaches have been canvassed, with some attention beingpaid to the notion of a bit tax. The bit tax is a radical or even a revolutionarynotion because it does not fit into the framework of income or consumption taxation.

    In essence, this will involve charges being levied upon Internet users dependent onthe volume of data transmitted to or from their equipment. Arthur Cordell andThomas Ide (1994) first proposed the notion of such a tax in 1994. Cordell and Ideargue that existing tax bases are no longer appropriate in an environment where majoreconomic activity is represented by the transmission of data.

    The report Building the Information Society for Us All [44], produced by a groupof independent experts appointed by the European Commission, suggested in 1996that the Commission investigate:

    'Appropriate ways in which the benefits of the Information Society (IS) can be more

    equally distributed between those who benefit and those who lose. Such researchshould focus on practicable, implement able policies at the European level, which donot jeopardise the emergence of the IS. More specifically, the expert group would likethe commission to undertake research to find out whether a bit tax might be feasibletool in achieving such redistribution aims'

    Cordell (1997) argues that a tax on gasoline did not slow down the development ofthe automobile industry [45] . However, this happened because of the implicitassumption of inelastic demand for cars. Whether the demand for accessing theInternet and more importantly the demand for using the Internet is inelastic remainsan open question.

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    The United Nations in the report Globalisation with a Human Face also argue infavour of bit tax. [46] This report advocated levying a tax on data sent over theInternet, with the finds used to support the development of a telecommunicationsinfrastructure in the least developed countries of the world. Statistics produced by

    NUA Surveys indicate a massive variation in access to and use of the Internet

    between the various regions of the world. Some 304.6 million people are estimated touse the Internet. A tax of 1 per cent per 100 e-mails, it is estimated, will yield anannual income of $70 bn. The UN proposal was not received with a warm welcome inthe developed world, where it was described as an unnecessary and burdensome taxon the Internet. To this end, the E.U. has also rejected the proposal of bit tax:

    'In order to allow electronic commerce operators to reap the full benefits of the SingleMarket (i.e. the European Market), it is essential to avoid regulatory inconsistenciesand to ensure a coherent legal and regulatory framework for electronic commerce atEU level In parallel, a number of key horizontal issues affecting the entireelectronic commerce activity need to be addressed. These include data security,

    protection of intellectual property rights and conditional access services, privacy, aswell as a clear and neutral tax environment.' [47]

    The main appeal of the bit tax is its ostensible simplicity. A specified tax rate willapply to the volume of interactive cyberspace traffic travelling over lines run bytelecommunications carrier companies and the resulting tax revenues will then flowdirectly to national governments. However, such simplicity may be more apparentthan real, for the bit tax presents vexing problems of how to accurately measure thevolume of data flow and how to precisely separate which data will be taxable andwhich will not. Consequently, tax collection will either be inflated or deflated,

    bringing unintended distortions in the tax base and instabilities in the tax system.

    Additionally, taxing business transactions in a different manner specifically becausethey are conducted by means of e-commerce violates the principle of tax neutrality.

    A distinguishing characteristic of the bit tax is that the entire burden of collecting andremitting the tax is borne by the carrier company. It can be argued that carriercompanies possess the necessary technical and labour resources to effectively performsuch a function. But , who, in the final analysis, will shoulder the bulk of the tax

    burden or incidence? Will carrier companies absorb the cost, or will they pass it ontoconsumers? If carriers choose to pass the costs onto consumers (a reasonableassumption it appears), will they do so in a non-neutral manner because carriers lackthe means to accurately separate e- commerce from non-e-commerce data flows?

    With a bit tax, there could also be problems with enforcing compliance on the part ofcarrier companies. Without a central international regulatory agency to oversee thecarriers, there would be difficulties in ensuring that companies collect the correctamount of tax and accurately allocate the funds to the designated governments.

    The arguments put forward for the bit tax are not grounded in free market basedeconomic principles, but rather in moral and sociological reasoning. With limitedexceptions, a free market operates most efficiently when taxes are designed tominimize interference with production processes. Thus, the burden of taxation islimited to the revenue raised and there is no additional cost the lower the economicoutput. A bit tax fails this basic principle of taxation because it would discourage

    electronic transmission of information. Economic resources would be wasted throughefforts to minimize the bit tax. Further, it would also be counterproductive in that it

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    burdens e-commerce and its productivity .For example, software companies mightcontinue to ship magnetic tapes and cartridges rather than use the more efficientmethod of transmitting the data electronically.

    The electronic transmission of information is highly efficient and thus extremely low

    in cost. Proponents of the bit tax further argue that the price of electronictransmission does not reflect true value. They argue for taxing electronic transmissionaccording to bits rather than value, as is the case under a value-added tax. Experiencehas shown that when prices are set by social planners rather than by the operation ofthe free market the loss of economic efficiency can be enormous. There is no reasonto believe that the marketplace cannot adjust pricing systems to better align priceswith resource availability. With regard to the bit tax freeing up Internet resources,while congestion on the existing Internet is a valid issue today, discouraging use ofthe Internet would not be a desirable goal. It is premature to conclude that existingtaxes cannot be successfully adjusted to accommodate technological innovations. Thesolution to these problems lies not in new taxes, but rather in technology itself. What

    is required is clearly defined tax compliance requirements, reasonable adjustments toexisting tax rules, and taxpayer adaptation to new compliance requirements.

    4. OECD TAG Proposals

    The OECD has committed itself to a post-Ottawa agenda of 'developing options forensuring the continued effective administration and collection of consumption taxes'.[48] The endeavour is to be undertaken in a spirit of cooperation and consultationamong governments and affected industries. The OECD's agenda focuses in the mainon consumption taxes on international B2C services. The OECD Working Party onConsumption Taxes has proposed five possible mechanisms for the collection of

    consumption taxes:

    Self-assessment;

    Registration of non-resident suppliers;

    Tax at source and transfer;

    Collection by trusted third parties; and

    Technology based solutions

    Each of the collection mechanisms the Working Party has identified has its merits andmight be suitable and workable in different circumstances. To evaluate the suitabilityand workability each mechanism the Working Party considered three criteria. Thefirst criterion was the feasibility of implementation. Does the mechanism have achance of implementation? The second criterion was the compliance burden. Thecosts for business of implementing and applying the mechanism should not be so highthat it would prevent compliance and encourage avoidance and evasion. The third andfinal criterion was the administrative burden. If perception costs aree too high,levying consumption taxes becomes inefficient.

    The first collection mechanism the Working Party examined was self-assessment, alsoreferred to as Reverse Charge. Under a self-assessment system, recipients would be

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    required to determine the tax owing on imports of digital supplies and to remit thisamount to their domestic tax authority. While this mechanism is very suitable fortransactions where the recipient is a business, it is unpractical for transactions wherethe recipient is a private consumer. This mechanism, to a smaller or larger extent, isused for business-to-business transactions in most OECD-countries. It has proven

    feasible and effective and carries a low compliance and administrative burden. Fortransactions involving private customers, however, it is highly ineffective. Taxing a

    private customer for the digital supplies he had received would be very burdensomeon both the consumer and the tax authority in terms of compliance and control.Taxing private individuals using this mechanism also delivers high compliance andadministrative costs. Asking consumers to keep books and to control those books isgoing to be wasteful and burdensome on both taxpayers and tax administrations. Thismeans that the risks of evasion and avoidance would be high. Therefore, self-assessment can only be considered as an option for business-to-business transactions.

    The second Collection Mechanism the Working Party worked on was registration of

    non-resident suppliers. A registration system obliges a non-resident seller of digitalsupplies to register in a jurisdiction in which he has made sales. After registration, theseller will be required to charge, collect, and remit the consumption tax to the countryin which the consumption took place. For example, a French seller of digital music,selling music to customers in Canada, will have to register in Canada. He will thenhave to charge and collect Canadian consumption tax and remit the tax to theCanadian tax authorities. From an administrative point of view, registration of non-resident suppliers will for the most part be feasible and effective. Since theregistration of non-residents will not directly require bilateral or multilateralarrangements, this mechanism is relatively easy to implement [49] . Difficulties arisein terms of identifying non-resident suppliers as well as in imposing registration

    requirements and enforcing obligations on non-residents. This mechanism cantherefore increase the costs for tax administrations and for businesses. This will beparticularly true for businesses making supplies in multiple jurisdictions. Withoutinternational co-operation, there will also be a risk that businesses will not comply. Inthe absence of international co-operation, this mechanism depends on the voluntarycompliance of non-resident suppliers. To encourage voluntary compliance,registration, and remitting the tax is required to be as simple as possible.

    The third collection mechanism the Working Party examined was the Tax at Sourceand Transfer system. Under this system, a business will collect consumption tax onsales made to non-resident consumers and remit the tax due to its domestic revenue

    authority. In turn, the domestic revenue authority will forward the tax revenue to therevenue authority of the country of consumption. This system shares some featureswith the registration system. A major difference of course being that under a systemof tax at source and transfer, suppliers of digital supplies will not be required toregister abroad. Businesses can handle their foreign consumption tax responsibilitieswith their national tax authorities. However, this mechanism requires tax revenue to

    be transferred from one tax jurisdiction to another. This means that considerableinternational agreement will be needed, which would make this mechanism difficultto implement. The significant compliance cost associated with the registrationmechanism will be largely avoided by the tax at source and transfer mechanism. Thishowever will be replaced by significant administrative costs that come with the

    required international co-operation.

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    The fourth option the Working Party considered was an entirely new system wherethird parties will be enlisted to collect consumption taxes on transactions betweenrecipients and suppliers of digital supplies. A Trusted Third Party will monitor thetransactions between buyers and sellers and charge the buyers consumption taxes andremit these taxes to the tax authorities of the countries where consumption took place.

    If a Trusted Third Party is to take on the levying and recovery of certain taxes, bothcompliance and administrative costs would be kept to a minimum. If simplicity is theguiding criterion, as it should be, there must be a strong case for trusted third parties.A business really wants to deal with as few external bodies as possible and also wantsto deal with bodies that have a good commercial reason to be helpful. If a businessonly needs to deal with one third party, but can choose between several competingthird parties based on quality of service that is likely to produce the best outcome allround. Much of the success of the mechanism depends on the legal relationships

    between businesses, third parties, and tax authorities and will need to be correctlystructured. The feasibility of this mechanism, however, is a point of concern. Shiftingthe onus of collection onto a commercial organisation is troublesome. Today, many

    consumption taxes are collected by businesses that do not receive compensation forthis imposed task. Granting a fee for the collection of consumption taxes in the fieldof e-commerce makes it difficult to deny an allowance in other fields. Ideally, taxcollection will be part of a package of services for which the supplier is willing to

    pay.

    The fifth and final mechanism for collecting consumption taxes the Working Partystudied was Technology driven options. Various technology-based and technology-facilitated options were debated. One such approach involves the use of tamper-proofsoftware which automatically calculates the tax due on a transaction and remits(through a financial intermediary) the tax to the jurisdiction of consumption

    Technology based or technology facilitated options offer a broad range of possiblemechanisms. As these mechanisms are still to be developed, it is possible toincorporate requirements for feasibility and effectiveness into the development

    programs. Doing this will produce mechanisms that not only carry low administrativeand compliance costs but also can be easily implemented. Currently such technologydriven collection mechanisms are being developed. They will probably be available inthe medium term.

    However, none of these methods is perfect, but several of them can be used togetherto provide a reasonable level of assurance. The need for simplicity provide someguidance on who should be registered for tax and with which authorities. The need

    for automation makes it clear that any feasible solution must be technological to ahigh degree. The WP9 paper argues that technology can support any part of theoverall compliance model [50] . However, one can go further and say thattechnology-based solutions should not be seen as a separate class of solutions at all.They simply provide ways to make it easy for taxpayers to account for tax and to givetax authorities the confidence that they are collecting the right amounts of tax.

    For the time being, the OECD favours some form of a registration-based mechanismfor B2C transactions, however, they also acknowledges that this system has itsshortcomings. Even so, the OECD remains confident in its general direction. TheOECDs insists on tax neutrality between electronic and conventional commerce and

    insists on protecting each countrys local tax base. This requires of member countries

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    and their tax authorities a very strong level of administrative cooperation and theorganization is committed to generating that cooperation.

    5. Conclusion: Are We Close to a Solution?

    The problem is we are as far as we were a few years back. However, all these yearsendeavours have made one thing certain: the solution is not going to come only fromachieving the right principles, it will have to be supported by technology. So, whathappens next? Does this unprecedented phenomenon of e-commerce necessarilyargue for the creation of a new tax system? Does it require simplification techniquesin compliance and administration areas? Most scholars argue that the creation of anew tax system is perhaps a far-fetched thought. However, in an attempt to resolvetaxation issues,'out-of-the-box' thinking is a good first step. Consideration should begiven to a proposal aimed at a long time solution.

    The simplest approach to the problem will be a multilateral solution. If all countries

    agree to remove consumption tax exemptions for exports and to remit taxes collectedto the customers' countries, neutrality and the tax base will be protected. A solutionalong these lines might be feasible within an economic union such as the EuropeanUnion [51] or the United States, [52] but the odds of a looser economic grouping suchas ASEAN devising a similar arrangement are tiny and the chances of a move to amultilateral treaty applying generally are virtually non-existent. Even if such a systemcould be established, it would quickly lead to the establishment of virtual distributorslocated in low consumption tax jurisdictions, unless the multi-lateral agreement wasaccompanied by the universal harmonisation of consumption taxes, a completelyunrealistic prospect.

    It has not been the aim of this paper to suggest a solution however; any proposal willhave to be flexible and dynamic and should have the capability to adapt according tothe needs of the different perspectives and components that constitutes e-commerce.If the proposal is looked at from a business perspective, it will require providing thenecessary elements that are useful for the development of e-commerce as a successful

    business process. Microeconomic theory predicts, [53] ceteris paribus, that consumerswill purchase online up until the marginal cost of a purchase equals its marginal

    benefit. If e-commerce transactions are subject to multiple taxation[54], then anypotential price reductions achieved from trading on-line will be more than offset bythe taxes imposed, thereby rendering e-commerce a fad of the 1990s. Accordingly, inorder to keep the goose that lays the golden eggs alive (e.g., promote e-commerce as a

    beneficial way of transacting business), the total amount of tax applied to e-commercetransactions must be less than or equal to the same amount of tax that the consumerswould otherwise face if the consumers purchased the identical goods or services fromtraditional brick and mortar retail establishments in their home-state. The inevitableconclusion is that in order to satisfy both the legal and economic constraints,consumption tax rates applied to e-commerce transactions must be apportioned. Thismeans that the compliance burden on sellers must be kept to a minimum. From a

    buyers point of view it must also provide the environment where buyers will be ableto comply with minimum effort. It can be suggested here that such a proposal must becapable of using the existing workflow and the technology. However, creation of sucha system will require the refinement of administrative techniques, particularly in

    respect to collection and auditing methods. In particular, attention must be directed toelectronic information gathering and development of reference techniques to identify

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    taxpayers beyond any reasonable doubt. The best method in the short term may not bethe best method in the long term: new technology may change our preferences.However, guiding principles must be kept simple and must be realistic. Complexity

    puts businesses off and leads to their withdrawing co-operation. In addition, humanbeings are too precious a resource to spend on the routine administration of

    individually small amounts of tax.

    Notes and References

    [1] Deloitte & Touche LLP (1997) Consumption Tax Issues Briefs, FundamentalTax Reform, www.dtonline.com/TAXREF/trissue.htm

    [2] Hoffman, Philip T and Kathryn Norberg (1994) Fiscal Crises, Liberty andRepresentative Government (Stanford: Stanford University Press)

    [3] Hellerstein, Walter (2002) Electronic Commerce and the Challenge for TaxAdministration, World Trade Organization, Committee on Trade and DevelopmentSeminar on Revenue Implications of E-Commerce for Development, Geneva,Switzerland 22 April 2002

    [4] Richard Doernberg, Luc Hinnekens, Walter Hellerstein, and Jinyan Li, ElectronicCommerce and Multijurisdictional Taxation (2001); Karl Frieden, Cybertaxation: TheTaxation of E-Commerce (2000).

    [5] Jeffrey Owens (1997) The Tax Man Cometh to Cyberspace, paper presented at theHarvard Law School International Tax Program Symposium on MultijurisdictionalTaxation of Electronic Commerce, April 5,

    [6] Owens, Jeffrey (1997) 'The Tax Man Cometh to Cyberspace', paper presented atthe Harvard Law School International Tax Program Symposium on Multi-

    jurisdictional Taxation of Electronic Commerce, April 5, 1997

    [7] Supra Note 2

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    [8] Basu, Subhajit (2004) 'Implementing E-Commerce Tax Policy', British TaxReview, Number 1 pg 47

    [9] OECD (2002) Implementation of Issues of Taxation of Electronic Commerce ,Paris, Report of CTPA

    [10] Hellerstein, Walter (2001) 'Electronic Commerce and The Challenge For TaxAdministration' Paper presented to the United Nations Ad Hoc Group of Experts onInternational Cooperation in Tax Matters in Geneva, Switzerland, on September 12,2001 pp 16-18

    [11] McLure, Charles E Jr (1997) Taxation of Electronic Commerce: EconomicObjectives, Technological Constraints, and Tax Laws, Tax Law Review, Symposiumon Taxation and Electronic Commerce

    [12] Joel Slemrod (1990) 'Optimal Taxation and Optimal Tax Systems', 4 JournalEconomic Perspective pg 157

    [13] Due, John F. and John L. Mikesell, Sales Taxation: State and Local Structureand Administration 1-4 (2d ed. 1994) p 49

    [14] McLure, Charles E Jr (1997) Electronic Commerce, State Sales Taxation andIntergovernmental Fiscal Relations, National Tax Journal, Volume: 50 no 4, pp 731-49

    [15] OECD (2000) Committee on Fiscal Affairs, Implementing The Ottawa TaxationFramework Conditions

    [16] OECD (2000) Committee on Fiscal Affairs, Implementing The Ottawa TaxationFramework Conditions

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    [17] McLure, Charles E. Jr (1999) The Taxation of Electronic Commerce:Background and Proposal, Hoover Institution Stanford University, Prepared fordiscussion at a Hoover conference on 'Public Policy and the Internet: Taxation andPrivacy,' October 12, 1999; in Nicholas Imparato, editor, Public Policy and theInternet: Taxation and Privacy (Stanford: Hoover Press)

    [18] James S. Gilmore, III (2000) 'No Internet Tax: A Proposal Submitted to thePolicies & Options Paper Of the Advisory Commission on Electronic Commerce,'available at www.ecommercecommission.org.

    [19] Goolsbee, A. (2000) 'In a World without Borders: The Impact of Taxes onInternet Commerce', National Bureau of Economic Research (NBER) Working Paper

    No. 6863, Cambridge, MA

    [20] Congressional Budget Office, 2003, 'Economic Issues in Taxing Internet andMail-Order Sales', CBO Paper (CBO: Washington, DC).

    [21] Dixit, A.K., 1985, 'Tax Policy in Open Economies', in A.J. Auerbach and M.Feldstein, Eds. Handbook of Public Economics (North Holland: Amsterdam).

    [22] Zodrow, G.R., 2003, 'Network Externalities and Indirect Tax Preferences forElectronic Commerce,' International Tax and Public Finance, Vol. 10, pp. 79-97

    [23] Tanzi, V., 2000, 'Globalization, Technological Developments and the Work ofFiscal Termites,' IMF Working Paper, No. 181 (IMF: Washington DC).

    [24] Bruce, Donald, and William E Fox (2001) 'State and Local Sales Tax RevenueLosses from E-Commerce: Updated Estimates', Centre for Business and EconomicResearch, The University of Tennessee, Sept.2001

    [25] As reported by Cyber Atlas, Online Holiday Shoppers to Triple 9 November1999, available at www.cyberatlas.internet.com

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    [26] Perez-Esteve, R. and L. Schuknecht, 1999, 'A Quantitative Assessment ofElectronic Commerce,' WTO Working Paper, No. 01 (WTO: Geneva)

    [27] OECD, The Economic and Social Impact of Electronic Commerce: PreliminaryFindings and Research Agenda. Executive Summary, 19 August 1998, p 14

    [28] Ernst & Young (2000) Global Online Retailing, January 2000

    [29] Although the current trend in Dotcom companies in past one year was notencouraging but it is believed by most commentators that this downward trend would

    be temporary and was result of the much of wider economic stagnation .In any casefor the past two years major world economies were slowing down. It would appear incoming years that bust of e-commerce companies during this period was exceptionrather than rule

    [30] OECD (1998) The Economic and Social Impact of Electronic Commerce:Preliminary Findings and Research Agenda, 24August 1998,DSTI/ICCP(98)15/PART5, p 12,

    available at .

    [31] Ernst & Young (2000) Global Online Retailing, January 2000, p 47.

    [32] Jupiter Communications (1999) Press release, Digital Commerce Growth WillBe at Expense of Off-line Dollars, 4 August 1999. Available at.

    [33] To ensure that only final consumption is taxed, tax levied at previous stages ofproduction and distribution needs to be fully credited against output tax

    [34] Diamond, P. and J.A. Mirrlees, (1971) 'Optimal Taxation and Public ProductionII: Tax Rules,' American Economic Review, Vol. 61, pp. 261-278

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    [35] Fox, W.F. and M.N. Murray, 1997, 'The Sales Tax and Electronic Commerce:So Whats New?' National Tax Journal, Vol. 50, pp. 573-592.

    [36] McLure, C.E., ( 2000) 'The Taxation of Electronic Commerce: Background andProposal,' in N. Imparato (ed.), Public Policy and the Internet: Privacy, Taxes andContract (Hoover Press: Stanford).

    [37] OECD (2001) 'Consumption Tax Aspects of Electronic Commerce: A ReportFrom the Working Party No. 9 on Consumption Taxes to the Committee on FiscalAffairs' (OECD: Paris).

    [38] McLure, C.E., ( 2000) 'The Taxation of Electronic Commerce: Background andProposal,' in N. Imparato (ed.), Public Policy and the Internet: Privacy, Taxes andContract (Hoover Press: Stanford)

    [39] Doernberg, R.L. and L. Hinnekens, 1999, Electronic Commerce andInternational Taxation (Kluwer Law International: London).

    [40] Charles E. McLure used this phrase to describe the consequences of taxing salesat their origin during testimony before Advisory Commission on E-Commerce onJune 22,1999.

    [41] Deloitte & Touch LLP (1996) Consumption Tax Issues Briefs, FundamentalTax Reform, available at .

    [42] Eggermont, Tino (1998) The Commissions work programme for the gradualintroduction of the new common VAT system, European Commission, 1998,Available at< http://www.ecu-activities.be/1998_2/eggermont.html>.

    [43] Lockwood, B (2001) Tax Competition and Tax Co-ordination under Destinationand Origin Principles: A Synthesis,' Journal of Public Economics, Vol. 81, pp. 279-319.

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    [44] Whalley, J. (1979) 'Uniform Domestic Tax Rates, Trade Distortions andEconomic Integration,' Journal of Public Economics, Vol. 11, pp. 213-221

    [45] Available from

    [46] Cordell, A and Ide, J (1994) The New Wealth of Nations-Taxing Cyberspace,Buenos Aires, Argentina: Between the Lines Publishers, paper prepared for annualMeeting of the Club of Rome, November

    [47] Available from , published in July 1999

    [48] A European Initiative in Electronic Commerce (1997) Communication to theEuropean Parliament, the Council, the Economic and Social Committee and theCommittee of the Regions, COM(97) 157. May 1997.

    [49] OECD (2001) 'Taxation and Electronic Commerce: Implementing the OttawaTaxation Framework Conditions', p 6

    [50] EU is applying VAT on Digital sales using the principle of this system

    [51] paragraph 53 Working Party 9

    [52] Lejeune, I. Cambien, J-M. and Joostens, M. (1999) "E-commerce: The EuropeanCommission" 4, VAT Monitor vol. 10, p 156

    [53] McLure, Charles E Jr (2000) "How and Why the States Should Tax ElectronicCommerce" (2000, January 10) State Tax Notes 129

    [54] Rosen, Harvey S (1999) Public Finance, (5th Ed., 1999) Marginal Analysis p. 5