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Taxation of cross-border electronic commerce

More and more cross-border commercial activities are taking place on the Internet. In the new electronic business environment, suppliers and customers can conclude agreements and transactions without regard to physical or national frontiers. This makes existing principles of international tax law difficult to apply.
Neither Slovakia nor other countries have legislated new tax rules to deal with electronic commerce. Below are some of the tax issues posed by electronic commerce, which can represent certain tax risks for subjects doing business through the Internet.

More and more cross-border commercial activities are taking place on the Internet. In the new electronic business environment, suppliers and customers can conclude agreements and transactions without regard to physical or national frontiers. This makes existing principles of international tax law difficult to apply.

Neither Slovakia nor other countries have legislated new tax rules to deal with electronic commerce. Below are some of the tax issues posed by electronic commerce, which can represent certain tax risks for subjects doing business through the Internet.

Electronic commerce

Electronic commerce is the ability to perform consumer and business transactions over a network (mainly through the Internet) using computers and telecommunications. Web pages are now supplementing paper catalogues for many mail order companies and wholesalers. Computer software, that is created and used in digital form, can be sold and delivered electronically. Electronic research databases (on-line information) are in widespread use (offering legal materials, newspapers, magazine articles etc.). Consulting services are offered electronically. Trading with securities is developing rapidly through the Internet. Electronic money permits their users, in some environments, to move funds electronically.

In view of the massive expansion of commercial services and products being offered through the Internet, one of the most imperative tasks in the near future will be to integrate those new payment systems and ways of doing business into the system of tax compliance.

Basic tax issues related to electronic commerce

The essential question is how to apportion jurisdiction over tax income from cross-border electronic commerce. No adequate rules of play exist where taxpayers are considered to have income attributable to a permanent establishment (PE), nor do any laws give assurance that taxpayers will be protected from double taxation of their cross-border income.

1. Classification of income. Correct classification of digitized information (identification of goods, services and transfer or use of rights) is a precondition for a correct tax treatment. Distinguishing services income from sales or royalty income may be more difficult in the case of digitized information. What should be assessed is the nature of the underlying transaction rather than the manner in which it is carried out. The neutrality principle, preferred by many countries, requires that the tax system treats economically similar income equally, regardless of whether it has been earned through electronic means or through more conventional channels of commerce.

2. Source of service income. Traditional concepts such as geographic basis or physical presence are not clearly applicable to Internet transactions. On the other hand, new issues arise from electronic commerce, such as whether the location of the computer server of a service provider is essential in determining the source of income from services. With the prevailing trend towards global services, the allocation of income and expenses becomes more difficult, especially regarding the application of traditional transfer pricing rules and source of income principles. Therefore, we are seeing a move towards an exclusively residence-based taxation.

3. Permanent establishment issue. The crucial question to be solved in Slovakia is whether a computer server or a telecommunications link constitutes a "fixed place of business" for either the owner or the user. The Slovak Income Tax Act does not exclude the creation of such a permanent establishment (PE) by a non-resident of Slovakia. However, an Internet server can be compared to a warehouse, which generally (if a corresponding double tax treaty exists) would not in itself give rise to a PE. Other exclusions for PE treatment in double tax treaties (DTT) are display, maintenance of inventory, provision of information, preparatory or auxiliary activities etc.

Another tax issue is whether a non-resident should be considered (under an agency theory) as having a PE in the source country by imputation, because of the activities of an Internet service provider or telecommunications service provider (as an agent). Different principles might apply to determine whether a person engaged primarily in providing telecommunications services (rather than in selling goods and services) is engaged in trade or business in the source country and has a PE therein.

4. Transfer of intellectual property and copyrights and withholding taxes. Withholding taxes (WHT) on royalties, such as on those from software, is an important tax issue. It may be necessary to reexamine the definition of licenses (copyrights) under Slovak law and under existing tax treaties to take into account the unique characteristics of digitized information. The focus appears to be on electronic sales that may be viewed as substitutes for conventional physical transactions (e.g. the electronic sale of a book with the right to make a small number of copies electronically). Further difficulties may arise with respect to the application of WHT on some cross-border electronic transactions (e.g. a transfer of limited rights on software).

5. VAT and customs issues. According to the Slovak Customs Act, only tangible movable property (and electricity) is considered goods. From Slovak law it follows that the import of goods which are subject to customs duty and VAT in physical transactions are not subject to duty and VAT if delivered electronically. Slovak importers can utilize this fact. On the other hand, Slovak exporters could face problems if they do not charge VAT on some products or services delivered through the Internet.


Anna Frimmelová is a tax analyst with Deloitte & Touche who spent 3 months in the United Kingdom studying the taxation of electronic commerce

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