Taxing E-Commerce in a Global Economy:Taxing E-Commerce in a Global Economy:Old Issues, New Media, New OpportunitiesOld Issues, New Media, New Opportunities

presentation topresentation to

Advisory Commission on Electronic CommerceAdvisory Commission on Electronic Commerce

byby

Peter R. MerrillPeter R. MerrillPricewaterhouseCoopers LLPPricewaterhouseCoopers LLP

Williamsburg, VAWilliamsburg, VAJune 22, 1999June 22, 1999

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ContentsContents

What is e-commerce?What is e-commerce?

A brief history of e-commerceA brief history of e-commerce

Some facts and figuresSome facts and figures

Tax policy implicationsTax policy implications

Suggested principles to guide tax policySuggested principles to guide tax policy

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What is e-commerce?What is e-commerce?

A broad definitionA broad definition Interactions possessing three attributes:Interactions possessing three attributes:

(1) between two computer applications,(1) between two computer applications,

(2) completes all or part of business transaction, and(2) completes all or part of business transaction, and

(3) crosses enterprise boundaries.(3) crosses enterprise boundaries.

Includes business applications over VANs that have Includes business applications over VANs that have been used for decadesbeen used for decades

Electronic data interchange (EDI)Electronic data interchange (EDI) Credit card and debit card transactionsCredit card and debit card transactions Electronic fund transfers (EFT)Electronic fund transfers (EFT)

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What is e-commerce?What is e-commerce?

A narrower definition (i-commerce)A narrower definition (i-commerce) Limited to business applications over open Limited to business applications over open

networks using non-proprietary protocols networks using non-proprietary protocols such as the Internetsuch as the Internet

Defined narrowly, e-commerce is barely four Defined narrowly, e-commerce is barely four years old!years old!

Includes b2b applications over open Includes b2b applications over open networks as well as b2c applicationsnetworks as well as b2c applications

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What is e-commerce?What is e-commerce?

Business-to-consumer (b2c) examplesBusiness-to-consumer (b2c) examples RetailRetail -- catalogue, configuration, sale, payment -- catalogue, configuration, sale, payment Broker, agentBroker, agent -- auction, travel, auto, real estate-- auction, travel, auto, real estate EntertainmentEntertainment -- gaming, gambling, music-- gaming, gambling, music CommunicationsCommunications -- e-mail, e-cards, net radio-- e-mail, e-cards, net radio Financial servicesFinancial services -- securities, insur., banking-- securities, insur., banking PublicationPublication -- newspapers, magazines-- newspapers, magazines DatabaseDatabase -- directories, maps-- directories, maps Professional servicesProfessional services -- “tele-medicine”-- “tele-medicine” EducationEducation -- “distance learning”-- “distance learning”

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History of e-commerceHistory of e-commerce

Source: OECD, The Economic and Social Impact of Electronic Commerce, 1999.Source: OECD, The Economic and Social Impact of Electronic Commerce, 1999.

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History of e-commerceHistory of e-commerce

E-commerce is more a way of doing E-commerce is more a way of doing business than a sectorbusiness than a sector

““In five years, there won’t be any Internet In five years, there won’t be any Internet companies because they will all be Internet companies because they will all be Internet companies. Otherwise, they will die.”companies. Otherwise, they will die.”-- Andy Grove, Intel-- Andy Grove, Intel

Prior changes in communications Prior changes in communications technologies also have led to evolution of technologies also have led to evolution of business modelsbusiness models

telegraph, telephone, radio, TV, facsimile, etc.telegraph, telephone, radio, TV, facsimile, etc.

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Facts and figuresFacts and figuresU.S. i-commerce salesU.S. i-commerce sales

B2c gets the headlines, b2b gets the dollarsB2c gets the headlines, b2b gets the dollars b2b accounts for 85%+ of sales in 1999b2b accounts for 85%+ of sales in 1999

Much higher if we count EDI, EFT, etc.Much higher if we count EDI, EFT, etc.

b2b is projected to grow much faster, b2b is projected to grow much faster, reaching over 90% of i-commerce by 2001reaching over 90% of i-commerce by 2001

b2b migration from VANs to the Internet permits b2b migration from VANs to the Internet permits cost effective use by smaller enterprisescost effective use by smaller enterprises(“EDI lite”)(“EDI lite”)

Source: Forrester Research Inc., Nov. 1998Source: Forrester Research Inc., Nov. 1998

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Facts and figuresFacts and figuresb2c is a small share of Internet commerceb2c is a small share of Internet commerce

US Internet Commerce, 1998-2003

16% 14% 12% 9% 8% 8%

84% 86% 88% 91% 92% 92%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1998 1999 2000 2001 2002 2003

Source: Forrester Research, Inc. (Nov. 1998)

US b2c

US b2b

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Facts and figuresFacts and figuresUS direct market sales to consumersUS direct market sales to consumers

E-commerce is a tiny share of direct market E-commerce is a tiny share of direct market salessales

Internet sales to consumers are less than 3% Internet sales to consumers are less than 3% of all direct market sales to consumers (est. of all direct market sales to consumers (est. 1999)1999)

Internet sales to consumers amount to less Internet sales to consumers amount to less than 4/10 of one percent of U.S. personal than 4/10 of one percent of U.S. personal consumer expenditures (est. 1999)consumer expenditures (est. 1999)

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Facts and figuresFacts and figuresInternet is a tiny % of direct market consumer salesInternet is a tiny % of direct market consumer sales

Value of U.S. Direct Market Driven Consumer Sales, 1998-99

8 18

612.2

674.0

0

100

200

300

400

500

600

700

800

1998 1999Sources: Direct Marketing Assoc. and Forrester Research, Inc.

Bil

lio

ns

of

do

llar

s

InternetTotal

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Facts and figuresFacts and figures

To date, Internet companies have small profitsTo date, Internet companies have small profits

Combined total from most recent financial Combined total from most recent financial statements of 15 large Internet companies:*statements of 15 large Internet companies:*

Revenues Revenues $5.1 billion$5.1 billion

Net incomeNet income $-0.4 billion$-0.4 billion

*Amazon, AOL, CDnow, CompuServe, E*Trade, eBay, Excite, *Amazon, AOL, CDnow, CompuServe, E*Trade, eBay, Excite, Infoseek, Lycos, N2K, NetGrocer, ONsale, PeaPod, Preview, Yahoo!Infoseek, Lycos, N2K, NetGrocer, ONsale, PeaPod, Preview, Yahoo!

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Facts and figuresFacts and figures

International revenues are significant for some International revenues are significant for some U.S. firmsU.S. firms

Company Segment Int’l revenue (%) CDnow Music 35%Music Boulevard Music 33%Amazon Books 26%FirstParts Components 30%Virtual Dreams Adult entertain. 25%Source: OECD, The Economic and Social Impact of Electronic Commerce, 1999, p. 100.

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Facts and figuresFacts and figures

U.S. dominance of global e-commerce U.S. dominance of global e-commerce market is projected to declinemarket is projected to decline

Mid-range estimates put U.S. share of global Mid-range estimates put U.S. share of global i-commerce sales at i-commerce sales at

about 80% in 1999about 80% in 1999declining to less than 60% in 2003.declining to less than 60% in 2003.

Source Forrester Research Inc., 1998Source Forrester Research Inc., 1998

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Facts and figuresFacts and figures

I-commerce Sales: U.S. as a percent of Global, 1998-2003

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1998 1999 2000 2001 2002 2003Source: Forrester Research, Inc., Nov. 1998

High

Low

Middle

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Facts and figuresFacts and figures

E-commerce is contributing to U.S. E-commerce is contributing to U.S. economic growth by raising productivityeconomic growth by raising productivity

Improved supply chain management and Improved supply chain management and reduced inventory costsreduced inventory costs

Reduced distribution, marketing, and customer Reduced distribution, marketing, and customer service costsservice costs

The OECD estimates b2c commerce The OECD estimates b2c commerce potentially will increase total U.S. factor potentially will increase total U.S. factor productivity by 0.50%-0.67%productivity by 0.50%-0.67%

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Tax policy implicationsTax policy implications

Don’t let advocates of radical tax change Don’t let advocates of radical tax change use e-commerce as a pretext.use e-commerce as a pretext.

Remote sales have been with us since at least Remote sales have been with us since at least the Sears & Roebuck catalogthe Sears & Roebuck catalog

The Internet is a tiny share of remote sales, and The Internet is a tiny share of remote sales, and a negligible percentage of all consumer salesa negligible percentage of all consumer sales

Excluding services (which generally are not Excluding services (which generally are not subject to retail sales tax), most b2c Internet subject to retail sales tax), most b2c Internet sales are delivered exactly like mail ordersales are delivered exactly like mail order

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Tax policy implicationsTax policy implications

The tax system can cope with e-commerce. The tax system can cope with e-commerce. Though the medium is new, the issues are old.Though the medium is new, the issues are old.

See Howley v. Whipple, 48 N.H. 487 (1869) in which See Howley v. Whipple, 48 N.H. 487 (1869) in which the court opined that writing and signatures the court opined that writing and signatures communicated electronically through the telegraph communicated electronically through the telegraph were equivalent to pen and ink.were equivalent to pen and ink.11

11See: Boyle, Peterson, Sample, Schottenstein, and Sprague, “The Emerging International Tax See: Boyle, Peterson, Sample, Schottenstein, and Sprague, “The Emerging International Tax Environment for Electronic Commerce,” Tax Management Memorandum, February 18, 1999.Environment for Electronic Commerce,” Tax Management Memorandum, February 18, 1999.

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Tax policy implicationsTax policy implications

Currently, tax revenue losses due to e-Currently, tax revenue losses due to e-commerce (if any) are very smallcommerce (if any) are very small

Goolsbee and Zittrain (1999) estimate that sales tax Goolsbee and Zittrain (1999) estimate that sales tax revenues are reduced by less than 1/4 of 1 percent in revenues are reduced by less than 1/4 of 1 percent in 19981998

Less if Internet substitutes for mail orderLess if Internet substitutes for mail order This does does not take into account offsetting revenue This does does not take into account offsetting revenue

gains due togains due toProductivity growth from business efficiency gainsProductivity growth from business efficiency gainsStock market gains spurred by e-commerceStock market gains spurred by e-commerce

Potential revenue loss from direct taxes also is minimal Potential revenue loss from direct taxes also is minimal due to current absence of profits.due to current absence of profits.

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Tax policy implicationsTax policy implications

E-commerce highlights a number of E-commerce highlights a number of anomalies and weaknesses in tax systemsanomalies and weaknesses in tax systems

Federal and state telecommunications taxes Federal and state telecommunications taxes have become outdated due to deregulation and have become outdated due to deregulation and convergence of technologiesconvergence of technologies

The current system is too complexThe current system is too complex30,000 potential sales tax jurisdictions in US!30,000 potential sales tax jurisdictions in US!

Forexia case (UK VAT). Delivery of a newsletter Forexia case (UK VAT). Delivery of a newsletter as a hard copy vs. e-mail or fax.as a hard copy vs. e-mail or fax.

Jurisdictions must coordinate to avoid double-Jurisdictions must coordinate to avoid double-taxation of border-crossing transactionstaxation of border-crossing transactions

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Tax policy implicationsTax policy implications

Market-driven technological developments will Market-driven technological developments will provide tools for assuring tax complianceprovide tools for assuring tax compliance

““Many software manufacturers and e-business Many software manufacturers and e-business merchants would like to be able to identify clients merchants would like to be able to identify clients uniquely.”uniquely.”11

Tax administration should follow, not lead, Tax administration should follow, not lead, technological development of e-commerce.technological development of e-commerce.

Business participation in development of tax standards Business participation in development of tax standards is essential.is essential.

11PricewaterhouseCoopers, E-business Technology Forecast, 1999, p. 192.PricewaterhouseCoopers, E-business Technology Forecast, 1999, p. 192.

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Tax policy implicationsTax policy implications

E-commerce technology has the potential to E-commerce technology has the potential to dramatically lower costs of business to tax dramatically lower costs of business to tax administrator (b2a) transactionsadministrator (b2a) transactions

Electronic tax registrationElectronic tax registration Electronic tax filing and paymentElectronic tax filing and payment Dissemination of tax information on government Dissemination of tax information on government

web sitesweb sites

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Tax policy implicationsTax policy implications

Tax administrators’ fears that electronic Tax administrators’ fears that electronic records are more easily altered are without records are more easily altered are without foundation.foundation.

For commercial reasons, firms must ensure the For commercial reasons, firms must ensure the security and integrity of their electronic security and integrity of their electronic transactions and recordstransactions and records

Sophisticated auditing procedures are being Sophisticated auditing procedures are being developed for use by internal and external developed for use by internal and external auditors, who must satisfy themselves of the auditors, who must satisfy themselves of the integrity of electronic systems and records.integrity of electronic systems and records.11

1 PricewaterhouseCoopers, “The Technologies of Electronic Commerce: The Integrity of Electronic Transactions and Digital Records for Tax Administration and Compliance,” prepared for the Electronic Commerce Tax Study Group (August 1998).

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Tax policy implicationsTax policy implications

Tax authorities should not discourage new Tax authorities should not discourage new technology to protect familiar ways of doing technology to protect familiar ways of doing business.business.

Such measures will reduce potential productivity Such measures will reduce potential productivity and national income gains.and national income gains.

U.S. and foreign tax authorities should U.S. and foreign tax authorities should recognize that U.S. dominance of recognize that U.S. dominance of e-commerce is transient.e-commerce is transient.

Discriminatory application of VAT and other Discriminatory application of VAT and other taxes will slow efficiency gains.taxes will slow efficiency gains.

OECD is seeking to build consensus among OECD is seeking to build consensus among member states and developing countries.member states and developing countries.

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Tax policy implicationsTax policy implications

Neutral application of tax rules and Neutral application of tax rules and government regulation is criticalgovernment regulation is critical

Convergence of technologies is causing Convergence of technologies is causing companies to cross industry boundaries (e.g., companies to cross industry boundaries (e.g., broadcasting over the web)broadcasting over the web)

Some products can be supplied in tangible or Some products can be supplied in tangible or intangible form (“digital goods”), but government intangible form (“digital goods”), but government regulations may treat these differentlyregulations may treat these differently

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Principles to guide tax policyPrinciples to guide tax policy

Commission’s deliberations should be Commission’s deliberations should be guided by four basic tax policy principles:guided by four basic tax policy principles:

1.1. NeutralityNeutrality

2.2. SimplicitySimplicity

3.3. Free tradeFree trade

4.4. Technological efficiencyTechnological efficiency

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Principles to guide tax policyPrinciples to guide tax policy

1. Neutrality1. Neutrality E-commerce should not be taxed at a higher E-commerce should not be taxed at a higher

rate than economically similar transactions rate than economically similar transactions conducted through traditional methods.conducted through traditional methods.

As a corollary, E-commerce transactions should not be As a corollary, E-commerce transactions should not be subject to special taxes that don’t apply generally.subject to special taxes that don’t apply generally.

E-commerce should not be held to a higher (and E-commerce should not be held to a higher (and more expensive) standard of compliance than more expensive) standard of compliance than traditional forms of commerce.traditional forms of commerce.

Tax administrators should respect the privacy of Tax administrators should respect the privacy of e-commerce transactions to the same extent as e-commerce transactions to the same extent as traditional commerce.traditional commerce.

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Principles to guide tax policyPrinciples to guide tax policy

2. Simplicity2. Simplicity Simplifying current tax systems will ease Simplifying current tax systems will ease

technological solutions to collecting tax on the technological solutions to collecting tax on the net.net.

Jurisdictions should harmonize the classification of Jurisdictions should harmonize the classification of goods and services, within both retail sales and VAT goods and services, within both retail sales and VAT systems, and limit the number of tax rates.systems, and limit the number of tax rates.

The application of current law to e-commerce The application of current law to e-commerce should be clarified where necessary.should be clarified where necessary.

Tax authorities should use e-commerce Tax authorities should use e-commerce technology to reduce compliance costs.technology to reduce compliance costs.

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Principles to guide tax policyPrinciples to guide tax policy

3. Free trade3. Free trade E-commerce imports should not be taxed more E-commerce imports should not be taxed more

heavily than similar domestic supplies.heavily than similar domestic supplies. Double taxation (by the country of export and the Double taxation (by the country of export and the

country of import) should be avoided.country of import) should be avoided. On-line provision of services and digitized goods On-line provision of services and digitized goods

should remain duty free.should remain duty free.Consistent with U.S. policy seeking to reduce tariff and Consistent with U.S. policy seeking to reduce tariff and non-tariff barriers to trade.non-tariff barriers to trade.

Consistent with current tariff schedules and customs Consistent with current tariff schedules and customs procedures that are applicable only to commodities.procedures that are applicable only to commodities.

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Principles to guide tax policyPrinciples to guide tax policy

4. Technological efficiency4. Technological efficiency Taxes should not interfere with the development Taxes should not interfere with the development

of efficient, market-driven e-commerce of efficient, market-driven e-commerce technologies and business models.technologies and business models.

This tax policy strategy will minimize compliance This tax policy strategy will minimize compliance costs and maximize efficiency.costs and maximize efficiency.

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ConclusionConclusion

There is no support for “Chicken Little” claims that the tax There is no support for “Chicken Little” claims that the tax system is hemorrhaging as a result of e-commerce.system is hemorrhaging as a result of e-commerce.

Nor is the healthy development of e-commerce Nor is the healthy development of e-commerce dependent on a perpetual tax moratorium.dependent on a perpetual tax moratorium.

Rather, the Commission should seek:Rather, the Commission should seek: Neutral taxation of alternative methods of conducting similar Neutral taxation of alternative methods of conducting similar

transactions.transactions. Simplification, so taxes can be collected at reasonable cost from Simplification, so taxes can be collected at reasonable cost from

both small and big businessesboth small and big businesses Utilization of e-commerce technology by tax authorities to lower Utilization of e-commerce technology by tax authorities to lower

compliance costs.compliance costs.