E-commerce defies easy tax definitions

Taxes are as certain in cyberspace as they are in life. Generally governments are of the opinion that if it doesn’t move, tax it, and if it does move, tax it anyway. Why should cyberspace be any different?

There are a number of reasons. Tangible products, licensing agreements, and services are each treated differently by tax staffers, but e-commerce defies such simple characterizations.

For example, when you purchase your newspaper at the local corner store, for taxation policy purposes it is a tangible product. Yet, when you access it on the Internet is it still a product, is it an intellectual property licence agreement (especially when a search engine accompanies the Web site) or is it a database service?

These differences matter in some places. In Europe there is a value-added tax charged on the actual newspaper but not on the exact same paper if transmitted over the Internet.

An additional dimension to e-commerce is its lack of respect for borders. E-commerce allows a buyer to shop for goods or services from places that do not charge sales tax. The ability to avoid paying these taxes erodes a local government’s tax base.

The problem of tax erosion is not new. The mail-order business poses the same problem for taxation authorities, but the global reach of the Internet greatly complicates the problem.

For example, the U.S. Supreme Court found that a state cannot require an out-of-state mail-order house to collect tax on a sale made to an out-of-state buyer where the company neither had a physical outlet nor a sales representative.

Unfortunately, subsequent decisions interpreted “physical presence” as meaning as little as sending an employee across a state border to service or install software.

Tax erosion prompted the Clinton administration to propose a “bit tax” that would tax the transmission of data itself, without regard for its content.

In Canada, whether you have to pay tax on computer software varies from province to province. In British Columbia no sales tax is paid on computer software because of a decision by that province’s Court of Appeal.

Ontario amended its provincial Sales Tax Act to specifically include computer software. However, custom software created for the specific needs of the initial buyer is not taxable.

The Federal Goods and Services Tax makes a similar distinction between off-the-shelf software and custom software with respect to how GST is collected. The federal government treats off-the-shelf software as a tangible good and a Canadian user importing the software from outside Canada must cough-up the GST at the moment of importation. All other software is treated as a service (even if transmitted on-line) and GST is paid by the supplier when it is exported.

The Income Tax Act also affects the information technology sector. Users of property, inventions, trade names, patents or similar property rights must hand over to Ottawa 25 per cent of any rental or royalty payment. However, the courts have interpreted that this section of the Tax Act does not apply to one-time lump sum licence fee payments. In addition, the Act does not apply to a user who has the copyright of reproduction, for example, the distributor who possesses the master copy.

Also, the Income Tax Act contains good news for investors. There are important research and development tax credits and numerous tax benefits for investing in Canada’s burgeoning high-tech community.

Taxation and the Internet is a complicated area and the law is constantly evolving. An experienced accountant in this area is an e-business’ best friend when tax time rolls around.

One thing is for certain. There is no escape from the long arm of the tax collector. Not even in cyberspace.

Goldstein writes on legal issues and technology and practices law in Toronto. The opinions expressed in this column are not to be taken as legal advice. He can be reached at [email protected].

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