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JILT 2004 (1) - Subhajit Basu







Principles for a New Tax

3. 'To Tax or Not to Tax'
3.1 Destination or Origin Based Taxation
3.2  Bit Tax
4 OECD TAG Proposals
5 Conclusion: Are We Close to a Solution?

Notes and References

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


Subhajit Basu
Lecturer in the School of Law, Queen’s University Belfast


The author would like to thank the two anonymous reviewers for their insightful comments and suggestions and Brent Hanks for his editorial work. The author assumes responsibility for all errors within this work.



Consumption taxation of e-commerce should be consistent with the basic principles of international taxation. In order to aid the policy-based discussion in relation to consumption taxation, this paper provides an outline of the fundamental policy concerns that arise in any thoughtful consideration of changes in a system of taxation. The paper explains in broad terms the objectives and principles that should guide the consumption taxation of e-commerce and it critically evaluates the different options forwarded primarily by the OECD for collection of consumption taxes.

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

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 in Consumption Taxation of E-Commerce ', 2004 (1) The Journal of Information, Law and Technology (JILT). <>. New citation as at 15/06/04: <>.

1. Introduction: The Nature of the Debate

The greatest challenge to a tax regime is its ability to adjust and adapt to a changing world. 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 and communications are made is the latest and perhaps the most demanding of these challenges’ (Deloitte & Touché, 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, viewed as a central function and prerogative of the state. The study of taxation had been largely a parochial issue. It focused, mainly, on national concerns. Globalisation however initiated international co-operation and the development of ‘international taxation’. However, even when an international perspective has been necessary, such as when concerning the taxation of truly multinational enterprises, it has usually been approached as an aggregation of national perspectives rather than by adopting a truly international one. This history of taxation now raises intriguing questions for the present day. Territorial States are not particularly well suited to the task of taxing non-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 clearly and in detail elsewhere[4] . Even so, it is appropriate to begin this discussion with some observations about the attributes of e-commerce that have significant implications for taxation, and the fundamental issues that these attributes pose for tax administration and also place in context the more technical consumption taxation issues to which most of the paper is devoted. Jeffrey Owens, Head of Fiscal Affairs for the OECD, back in 1997 identified six characteristics of the Internet that would influence the operation of tax systems.[5]

  • First, the ability of the internet to establish public and private global communications systems that are secure and inexpensive to operate. The simplicity and low cost associated with establishing an Internet presence infers that relatively unsophisticated enterprises can operate a commercial web site.
  • Second, the process of 'disintermediation' whereby the Internet eliminated or substantially reduced the need for intermediaries in the sale and delivery of goods and services, and in the provision of information. E-commerce requires a small number of distribution, sales representative, broker, and other professional intermediaries.
  • Third, the development of encrypted information, which protects the confidentiality of the information, transmitted on the Internet. Whilst it is possible to detect a message 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 and production. Private Intranet networks are now widespread in Multinational Corporations (MNE’s). The OECD estimates that at least two-thirds of Internet transactions take this form. This development produces a closer integration of transactions within an MNE and makes it increasingly difficult to separate out the functions carried out by related enterprises. This integration may also produce a dramatic synergistic effect--- the sum of the parts being much less than the integrated whole.

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

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

Owens also points out that there are several technical features of Internet and intranet systems 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 difficulty if not impossibility of tracing transactions; and the weak correspondence between a computer domain name (i.e., an Internet address) and reality (i.e., the actual geographic location of the addressee or the computer equipment used to transmit or receive the information). Owens’ observations remain as true today as they were when 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 the broad implications of the foregoing developments for territorially based taxing regimes[7]. First, there is the sheer magnitude of the increase in cross-border transactions. Second, to deter evasion, it is the responsibility of tax authorities to monitor economic activities. However, given the decentralized structure, the variety of transmission media, the binary format, and the various encryption and security measures, the tax authorities’ ability to monitor economic activity-involving e-commerce is impaired. Further, tax collection in the digital environment poses a number 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

· 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 of traditional consumption tax rules in each of these above stated areas, all of these issues are compounded by the potential for different implementing legislation in individual countries. In some instances, the potential for multiple laws addressing identical issues in different ways might be as challenging as finding any single way to address the underlying issue. In addition to creating high compliance costs for governments and suppliers, the implementation of inconsistent laws and definitions possibly will result in double taxation or unintentional non-taxation of e-commerce transactions[9] . Hence, from the standpoint of tax administration, the principal challenge remains how to implement geographically limited taxing systems in a technological environment that renders geographical borders essentially irrelevant.

The debate on taxing e-commerce has initially been focused on tangible products sold to businesses and consumers, which is not surprising given these transactions account for the largest percentage of e-commerce sales. However, this trade does not raise any fundamental taxation issues, because the proper destination-based consumption tax can be levied once the consignment passes through customs. However, if both the payment method and product is digitized—for example, downloaded software paid for with electronic cash—vast tax enforcement issues arise because the origin and destination of these transactions is obscured.To be able to effectively tax a consumption transaction under traditional taxation principles, tax collectors need to know where the transaction takes place and whether the transaction involves a good or service.Sellers of intangibles often do not know—and typically do not have a need to know—the physical location of their customers. Indeed, the anonymity of the Internet makes it very easy for customers to hide their identity and physical location for tax evasion and privacy reasons. Moreover, it may be difficult for the tax authorities to determine the location of the vendor, who typically collects the consumption taxes. For example, the vendor may sell its products using a Website on a 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 technologies have 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 that delivery through these channels alters the character of a product to such a degree that it should be considered as wholly new product, distinguishable from that delivered through traditional channels, and therefore treated as unique for tax purposes. Others believe that digitising a product does not alter the purpose of the product and therefore the digitised version should be treated the same for tax purposes as that delivered in physical form. Typically, countries apply differential tax rates to goods and 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 same product as a rented movie. In addition, tax administrators rely on following a 'paper trail' of transactions for auditing purposes, whereas digital transactions typically do not generate such records. Can and should these transactions be taxed?[10]The debate on the effective taxation of e-commerce has yielded a number of proposals on tax collection models, ranging from the traditional vendor collection model to models employing 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 regime would allow participants in e-commerce to pay and collect taxes in an administratively feasible fashion to those states with a legitimate claim on tax revenues?

2. Principles for a New Tax

The principle difficulty in developing an e-commerce taxing regime for consumption taxes is that the Internet is still a new medium whose full ramifications are not close to 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 change dramatically; neither the composition nor the nature of taxation is likely to change fundamentally.The OECD’s work on consumption taxes, which is firmly based on the Taxation Framework Conditions, expresses similar views. In this context, it is worth recalling the most relevant emerging conclusions of these conditions:

· First,the taxation principles that guide governments in relation to conventional commerce should also guide them in relation to e-commerce. In other words, no new taxes 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 intensified dialogue 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, efficiencyCompliance costs for taxpayers and administrative costs for the tax authorities 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 advance of a transaction. This includes knowing when, where and how the tax is to be accounted. Simplicity often conflicts with other important objectives of tax policy; where this is true, it is necessary to make trade-offs between simplicity and other objectives.

However, in spite of these international agreements, the taxation of e-commerce is no less 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 taxes and their effort to structure their affairs in order to minimize taxes payable. A second factor 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 in their approach to the taxation of e-commerce.

McLure (1997) argues that there should be few further principles to guide the deliberations in the area of tax policy. First, and most obviously, it will be important to avoid distorting choices of how to satisfy a given need, taxation rates should not differ, 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 choice of how to provide the following products: music (tapes or compact disks vs. downloaded from the Internet), movies (video cassettes vs. downloaded), and reading materials (printed books, magazines, and newspapers vs. downloaded). Second, it will be important not to distort the choice of technology used to provide particular intangible products and services: for example, the provision of television signals over the air using traditional broadcast technology, via cable using wires (provided by either cable companies or public utilities) and fibre optic cables, or via direct transmission to satellite dishes. Third, taxation should not affect the choices of whether and how to 'bundle' various goods and services for purposes of pricing. This means that there should be neutrality towards bundling. For example, whether to include software on compact disks sold with books and whether to use lump-sum prices or itemized charges for basic and enhanced telecommunications and for the services of ISPs and OSPs, including, especially, the bundling of content and Internet access. 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 of competition 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 whilst also ensuring that needed government expenditures are funded and that tax distortions are minimised. A significant part of this response will necessarily involve greater international co-operation. This international cooperation must also extend beyond bilateral treaties and even beyond multilateral agreements between signatories to ‘play 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 environment in order to avoid taxes on their sales and income. It should be noted here that this is not 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 technology by 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 to differential taxation, for example, to seemingly different products that satisfy the same underlying needs, to quite similar products that are delivered through different distribution channels, or to sources located elsewhere. How to achieve economic neutrality 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 given jurisdiction, but not to business purchases or to exports[13] . This is true whether a given product is tangible or intangible or a service and whether it is produced domestically 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 for VAT 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 are not required to charge VAT when they supply services to EU customers, causing competitive disadvantage. However, in response to this the EU Commission amended the VAT Directive and EU suppliers are no longer required to charge VAT on online transactions involving non-EU customers, ensuring competitive neutrality with respect 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 a neutral sales tax than to achieve a neutral VAT. He also argues that it will be equally difficult to eliminate two of the most glaring defects of state sales taxes in the US, the ‘bright-line physical presencetest for the use tax nexus and the exemption (or differential treatment) of intangible products and many services, though changes have long been high on the tax reform agenda in this area. But in order to do so, greater uniformity of state laws, simplified administrative procedures, rationalizing nexus rules as well as unifying the tax treatment of tangible and intangible products and services will be required.Otherwise, it will create an unacceptable burden of compliance, especially on small business firms making interstate sales, and aggravate the problem of pyramiding the collection of tax on both business inputs and sales to final 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 should be exempt, even if the later are taxed. This problem is ordinarily addressed by exempting certain goods (essentially those that are unlikely to be bought by households) and by allowing firms to buy on a tax-exempt basis. It is useful to ask here: Do households or business firms derive the most benefit from government services? To the extent that public services are provided primarily to households and are complementary to private consumption, it would be appropriate to levy a tax on consumption (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 are complementary 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 more appropriate. 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 remains as the major unsolved tax problem. So far, most countries and international organisations have shied away from a radical solution to this problem alleging it is impractical to implement. However, with the continuing growth in e-commerce, this cautious position will ultimately have to be reconsidered by the OECD and the international community. The OECD's development of guiding principles for a framework to tax international e-commerce transactions, including a desire to use traditional international tax principles that promote neutral treatment between physical commerce and e-commerce, low compliance costs, and flexible rules to keep pace with technological developments[15] is considered as positive step in the right direction. Indeed developments in technology will be indispensable at least for collection of consumption taxes on e-commerce to provide an automated tax charging and 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 four understandings/realizations. First, it may not be easy to achieve the objective of applying existing taxes to e-commerce. It may be necessary to rethink how some laws could be applied to make them suitable for the world of e-commerce. Second, some current tax laws, especially at the state level (US), make no sense; such features include‘nexus’ rules, especially as applied to mail order sales, the failure to tax sales of tangible products, intangible products, and services equally,and the application of sales taxes to many business purchases. Defects that were already troubling are now becoming increasingly untenable and require fundamental restructuring. Third, to solve 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 is little more than a temporary fix, one which overlooks many of the incredibly important longer-term effects of not taxing e-commerce.

The question of whether e-commerce must be taxed to level the playing field between e-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 significant distortions that will put conventional retailers at a great disadvantage. Others claim that the tax differential would merely inspire conventional retailers to migrate to the Internet and that if state governments are genuinely concerned about equity they should consider ‘harmonizing tax rates downward for local retailers,’ rather than imposing taxes on e-commerce to eliminate the tax differences. McLure (1999) compares e-commerce events to the history of mail-order catalogues and argues that e-commerce should be taxed[17] . He claims that policies based on the argument that there should be a moratorium on e-commerce taxation until e-commerce is ‘mature’ enough 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 way to stimulate the development of e-commerce[18] . In support of their position they cite the empirical work of Austan Goolsbee on the possible effects of imposing sales taxes and compliance costs on the Internet. Goolsbee (2000)[19] attempted to determine the price elasticity of demand associated with e-commerce sales and the sales and consumption choices that would follow from such taxes. Drawing upon data from a survey conducted by Forrester Research in late 1997, Goolsbee examined the demographic traits, residential characteristics, including local sales tax rates, and purchasing decisions of 25,000 users. His primary objectives were to determine how local sales tax rates affected each individual’s choice to purchase something online and how they affected the advantage amount of money spent online by the typical consumer. Goolsbee found that the coefficient on local tax rates was positive and significant, implying the higher the local sales tax rate, the greater the amount of money the average consumer would spend online. However, Goolsbee’s findings are not without their limitations. To begin with the growth of e-commerce has exploded since 1997. Moreover, it is conceivable that Goolsbee’s study suffered from a selection 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 growth enhancing effects of the 'network externalities' associated with Internet use; a person’s joining the network makes it larger, benefiting not only that person, but also the other participants. For example, the value of e-mail increases with the number of individuals who also have e-mail and thus are potential exchangers of e-mail messages. Individual users do not internalize these ‘spillovers’. As a result, too few people are using the Internet if the government does not subsidize access. These network externalities mainly exist in the early stages of a network’s 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 the U.S. population (56 percent in 2001) is using the Internet. Moreover, exempting sales over the Internet—and thus effectively subsidizing this trade—is 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 more carefully targeted instrument would be the subsidization of Internet access fees, but in the US and many other countries preferential treatment of Internet access already exists. Finally, Zodrow (2003) [22] concludes that there is no convincing direct empirical evidence available that shows that these network externalities are significant.

On the other hand, the proponents of taxing e-commerce point to the revenue losses associated with permanently exempting e-commerce. For instance, Bruce and Fox (2001) estimate that in 2001 e-commerce caused a total state and local government revenue loss of $13.3 billion. They predict that by 2006 this loss will more than triple to $45.2 billion, reaching as high as $54.8 billion by 2011 [23]. Perhaps this is why Tanzi [24] speaks of e-commerce transactions as rapacious 'fiscal termites' that eat away the consumption tax base. It is not only consumption tax revenues that are at stake here. Some countries levy customs duties on physical trade in digital media, which would be lost if these products were 'imported' electronically. Perez-Esteve and Schuknecht [25] argue, however, that the potential tariff revenue losses would be small. 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 is broad support in the WTO to exempt electronically delivered products from customs duties, thus it is no longer an issue for debate. The rationale is that import tariffs cause larger by-product distortions than consumption taxes. Moreover, it would not make sense to levy these duties if there is no fiscal border.

Exempting e-commerce sales thus distorts consumer behaviour and thereby creates efficiency losses. Moreover, firms will be encouraged to offer their products online where otherwise they would have established a physical shop. Given that elasticity of substitution 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 and electronic commerce would minimize efficiency losses. Remote sellers, however, point to the shipping and handling fees on Web-based trade that would offset any tax advantages that they currently enjoy. This may be true for low-value purchases such as 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 no shipping and handling fees on digital content.

However, the price benefits that online purchases are facilitating are not available to all. After analysing several surveys across a number of countries, the OECD concluded that: 'One consistent finding across many countries is that there is a strong positive correlation between the use of information technology (PC ownership, access to the Internet) and household income: for every $10 000 increase in household income, the percentage of homes owing a computer increases by seven points' [26] . US demographic figures from the Ernst and Young[27] report cited above indicate that while 53% of households have PCs, only 34% are online and only 17% have shopped online. Those online buyers had a weighted average annual income of $59 000, clearly indicating that online shopping is not available to all. Many families today simply cannot afford to purchase a computer. This situation is unlikely to change in the near term. Similar demographic figures can be found in all countries that have been part of or have experienced the growth of e-commerce. If similar studies were carried out in developing countries, the disparities would be more striking.

The incredible growth in e-commerce has also witnessed the creation of a small number of brands that have become global leaders in the marketing and distribution of their products through the Internet. The world’s most popular e-tailer is 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 is also evident in other market segments with e-tailers such as ‘Cdnow’ (for music) and ‘eBay’ (for auctions). These Internet companies have used their high market values to eliminate their competitors and to take over other companies with high market shares[28] . The January 2000 announcement of the merger of America Online, Time Warner and EMI is an example 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 upscale car auctioneer) in 1999.

Although the OECD has noted the prevalence of similar alliances and acquisitions in international 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 their growth strategy[30] . Of more concern to traditional retailers are the recent findings of ‘Jupiter Communications’, whose research indicates that the growth in e-commerce has 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 this figure would increase to 6.5% for Internet sales in 2002. Their data indicated that 94% of Internet sales were sales that traditional retailers would have expected to make. While some proportion of these sales would have been facilitated by the Internet operations of traditional retailers, the fact remains that most of the sales of the pure Internet e-tailers were sales poached from traditional retailers. The continuation of the preferential taxation treatment of e-commerce will continue to exacerbate the sales losses of traditional businesses as the e-tailers exploit their unfair advantage. It is expected that this may result in the forced closure of many traditional businesses offering services to local and remote communities. How will the local bookstore compete against the purchasing power of companies such as and 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-commerce and between conventional and e-commerce. Taxpayers in similar situations carrying out similar transactions should be subject to similar levels of taxation. Proposals to make the Internet a ‘consumption tax-free zone’ are attractive, but they will have potentially devastating economic, tax, and social consequences. For instance, making the Internet a ‘consumption tax-free zone’ would distort several dimensions of consumer and business choices: in favour of content delivered on-line, instead of in tangible forms, and in favour of products that could be delivered on-line as electronic content, relative to products that could not be (notably tangible products and services that 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 between telecommunications (presumably taxable) and Internet access. Moreover, equitably, both horizontally and vertically, it is grossly unfair . Particularly pernicious is the effect it will have on undermining local retail stores. By exempting a large and growing fraction of consumer purchases, this policy will require higher tax rates to raise a given amount of revenue. Finally, it will do nothing to remedy the problems of the existing system.

If preferential tax treatment continues with e-commerce and higher income earners are able to benefit from buying goods cheaper online through a distribution network not 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 subsidised by the non-application of sales/use taxes and VAT to e-commerce. It is also enlightening in this regard to look at what consumers are buying online. In order of most popular Internet purchases, consumers are buying computers, books, CDs, electronics, and toys. Given the demographics of online buyers outlined above these consumer items are not those that inherently need Government subsidisation.

Usage of the Internet and e-commerce is growing most quickly amongst those in society 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 on society, the current inequity in treatment between the distribution of goods and services purchased from traditional sources and those purchased over the Internet should be removed. In summary, taxing all e-commerce will perpetuate or aggravate compliance and administrative problems. However, exempting it will create inequities and distortions and will also aggravate existing problems of classification and compound 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 the buyer are located within the same taxing jurisdiction or at least within compatible trading systems. The collection and payment burden is placed upon the buyer, usually the retailer, while the economic cost is usually placed upon the consumer. The problem arises in relation to cross-jurisdictional sales where the source country differs from the destination country. Hence, cross-jurisdictional sales can be taxed based on either their destination (that is buyer’s domicile) or their origin (that is, the seller’s home state or country). The e-commerce debate has unfolded against the background of a consumption tax system that is largely based on destination principle.

Under the destination principle, exports are exempt from consumption tax—for example, a VAT or sales tax—and are subsequently taxed at the rate levied by the importing 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 perfect competition, 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. The destination 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 organisations such 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 this context, McLure[37] proposes a complete overhaul of the current U.S. sales tax system with a view to simplifying vendor’s compliance and tax administration considerably. His proposal consists of the following elements: (i) a single uniform tax base for all states including conventional commerce, services, and intangibles; (ii) an exemption for all business purchases and those merchants whose sales to consumers do 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 in the 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 will undermine the fiscal sovereignty of local governments.

The application of destination-based registration at a global level would yield an insurmountable compliance burden to globally operating firms in a world of more than 100 different VAT systems. Doernberg and Hinnekens[38] argue that to facilitate the process of destination-based registration a real-time online system should be provided where non-resident vendors can check the validity of VAT tax registration numbers of purchasers. Substantial international coordination between countries would be required not only to prevent blocs of countries from implementing mutually inconsistent tax policies (potentially giving rise to double or no taxation of trade 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 than origin-based taxation. Second, taxation of consumption is probably a better proxy for the benefits of public services than taxation of production. Perhaps most important is the political attraction of the destination principle. It is not difficult to understand why those 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 foreign competition would not. Under the destination principle market jurisdictions would collect the same tax on domestic and foreign production. Similarly, exporters would not likely take kindly to a suggestion that exports should be taxed. It is relatively easy, ignoring legal obstacles for the moment, to collect destination based taxes on tangible products. Where there are fiscal borders, as between nations that are not members 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 they ship goods. However, the increasingly important technological shift from the production and sale of physical to digital products will render destination-based taxation difficult to implement. In contrast to products traditionally sold in shops and in a format that gives them some physical content, digital goods do not have physical characteristics. Consequently, it is difficult to determine the location of purchasers. By comparison, origin-based taxation would be relatively easy to implement in this case.

In VAT and sales tax systems the destination model predominates, the idea being that consumption is the appropriate subject of taxation and the country in which goods are received receives the revenue generated by that consumption. This however has created 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 in doing so. On the other hand, the destination country has a revenue interest in enforcing compliance but has difficulty with enforcement, especially in relation to non-corporeal goods such as digital products purchased over the Internet.

· The source country saves money on enforcement and at the same time enjoys revenue gains in areas such as income taxes and property taxes. Thus businesses within such jurisdictions enjoy competitive tax advantages.

Further more, since destination-based taxation compels sellers to calculate report and remit consumption taxes for each jurisdiction in which the sales occur, it generates extravagant compliance costs, especially for small and medium sized firms. Even with the best intention and the best tax software, companies find it difficult to determine their tax remittance obligations in thousands of jurisdictions with different and constantly changing tax rates, definitions, and reporting requirements. Tax authorities, for their part, confront a regime of daunting administrative complexity. A destination system also requires a high degree of intergovernmental cooperation, as the imposition and enforcement of tax collection obligations on sellers who conduct their business abroad often requires their home government’s consent and cooperation. The only equilibrium point under a destination-based regime, moreover, is perfect collusion among all governments. A government that withholds its consent effectively places its domestic firms beyond the reach of foreign tax collectors and in that manner hands them a competitive advantage.

Will origin-based taxation solve these problems? While no solution is perfect and each 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 to implement.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 seller’s physical location.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 jurisdictions. Effectively, the major concerns raised by destination-based taxation would be answered.

Some scholars in the USA add that origin-based taxation also appears to solve most of 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 jurisdiction where the 'principal place of business' of the e-commerce seller is located, regardless of where the product is shipped or the service performed. The seller's sales are subject to one-tax rate and one jurisdiction's tax laws and regulations. The tax revenue thus generated 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 of ways. Another positive aspect is that the buyer's 'use tax' liability is statutorily extinguished even where his or her home state imposes a higher tax rate.

Because the e-commerce vendor is physically located in the state asserting taxing jurisdiction, there would be no question that nexus exists. Actual physical presence will satisfy due process nexus concerns as well as the substantial nexus requirements of the US Supreme Court. Another potential positive impact of origin-based taxing would be the maximizing of revenue collected. Because nexus considerations are eliminated, it is reasonable to assume that many transactions that currently escape taxation 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 will be greatly reduced. Finally, because the sale is taking place in one location, local taxes imposed in that jurisdiction will also be collected, eliminating the need for a uniform state tax rate, which many states might be legally or politically precluded from providing.

However, some commentators see this as a serious invasion of the purchaser's privacy as it will require the seller to obtain information from the purchaser and deliver that information 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. Further origin-based taxation will maintain the autonomy of local governments and other local 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 taxing jurisdiction and exports from the jurisdiction occur tax-free. Under an origin-based VAT, exports are subject to tax, and tax is applied only to the value that is added after importation. Under this proposal, as with brick and mortar retailers, the buyer is viewed as visiting the sellers’ location, rather than the seller visiting the buyers’ location. For example, if an online software company in the United Kingdom uploaded 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 a customer 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 they derive no benefits. Whether or not the digitised sale is taxable is to be determined by the seller’s state just as when a buyer physically enters a state to make a purchase. Since businesses are subject to audit, the expected compliance rate with origin-based tax rules is also very high. Mechanisms to enforce compliance with domestic consumption tax collection responsibilities are already in place, so a move to origin-based taxation would place no additional burdens on businesses and little (if any) new burdens on national tax administrations. A final benefit of origin-based taxation, although most governments do not see it that way, is that such a system fosters robust tax competition between states. Critics of origin-based taxation often warn 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 on their export sales. Although the design of a nation’s tax system can effect export competitiveness, the true burden facing domestic producers is the overall level of taxation. Thus, businesses subject to VAT collection responsibilities may not suffer any competitive disadvantages under an origin-based system if tax rates are kept at reasonable levels. A Deloitte & Touché paper put it this way:

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

The European Commission has recognized the inherent benefits of origin-based consumption taxes, albeit only on an internal basis. In its 1996 work program for the gradual introduction of a new common VAT system, the Commission announced its intention to advocate a switch from taxation at destination to taxation at origin for sales within Europe. The changes being contemplated are minor. ‘All transactions giving rise to consumption in the EU,’ a Commission paper states, ‘would be taxed from 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 base from developing countries to developed countries where digital contents originates, particularly to the US. (In essence, for B2B transactions the origin principle is tantamount 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 digital content preferentially, in order to prevent its providers from locating elsewhere. This implies that digital content will have a substantial competitive advantage over non-digital equivalents, which are taxed under the destination principle. This will create further 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 for trade among the former members of the Soviet Union. Theoretically, as argued by Lockwood [42] , the case for preferring destination-based over origin-based taxation based on efficiency grounds is strong, but not absolute. The modest theoretical case for the destination principle rests on its perceived neutrality: since as taxes are identical for all sales in a given jurisdiction, sellers have no incentive to locate in a low tax jurisdiction. Under an origin-based system, in contrast, jurisdictional variations with respect to both tax base and the tax rate at the margin will induce sellers 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 high premium on ‘locational neutrality’, a notion that holds that the tax system should not unduly 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 is discussed widely. Only under very restrictive assumptions, typically not met in practice, are the two principles equal. First, within each country the consumption tax rate should be the same for all commodities, though that uniform rate may differ across countries. Uniformity implies that relative producer prices are equated to relative consumer prices in each country. Second, bilateral goods trade between countries should be balanced [43], so that a change from taxing imports to exports would not have a significant revenue effect. Nonetheless, internationally a large majority ofgovernments 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 being paid to the notion of a ‘bit tax’. The ‘bit tax’ is a radical or even a revolutionary notion 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 on the volume of data transmitted to or from their equipment. Arthur Cordell and Thomas Ide (1994) first proposed the notion of such a tax in 1994. Cordell and Ide argue that existing tax bases are no longer appropriate in an environment where major economic activity is represented by the transmission of data.

The report ‘Building the Information Society for Us All’[44], produced by a group of independent experts appointed by the European Commission, suggested in 1996 that 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 research should focus on practicable, implement able policies at the European level, which do not jeopardise the emergence of the IS. More specifically, theexpert group would like the commission to undertake research to find out whether a ‘bit tax’ might be feasible tool in achieving such redistribution aims'

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

The United Nations in the report ‘Globalisation with a Human Face’ also argue in favour of ‘bit tax’.[46] This report advocated levying a tax on data sent over the Internet, with the finds used to support the development of a telecommunications infrastructure 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 to use the Internet. A tax of 1 per cent per 100 e-mails, it is estimated, will yield an annual income of $70 bn. The UN proposal was not received with a warm welcome in the developed world, where it was described as ‘an unnecessary and burdensome tax on 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 Single Market (i.e. the European Market), it is essential to avoid regulatory inconsistencies and to ensure a coherent legal and regulatory framework for electronic commerce at EU level… In parallel, a number of key horizontal issues affecting the entire electronic commerce activity need to be addressed. These include data security, protection of intellectual property rights and conditional access services, privacy, as well as a clear and neutral tax environment.'[47]

The main appeal of the bit tax is its ostensible simplicity. A specified tax rate will apply to the volume of interactive cyberspace ‘traffic’ travelling over lines run by telecommunications carrier companies and the resulting tax revenues will then flow directly to national governments. However, such simplicity may be more apparent than real, for the bit tax presents vexing problems of how to accurately measure the volume of data flow and how to precisely separate which data will be taxable and which 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 because they 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 and remitting the tax is borne by the carrier company. It can be argued that carrier companies possess the necessary technical and labour resources to effectively perform such 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 onto consumers? If carriers choose to pass the costs onto consumers (a reasonable assumption it appears), will they do so in a non-neutral manner because carriers lack the 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 of carrier companies. Without a central international regulatory agency to oversee the carriers, there would be difficulties in ensuring that companies collect the correct amount 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 based economic principles, but rather in moral and sociological reasoning. With limited exceptions, a free market operates most efficiently when taxes are designed to minimize interference with production processes. Thus, the burden of taxation is limited to the revenue raised and there is no additional cost the lower the economic output. A ‘bit tax’ fails this basic principle of taxation because it would discourage electronic transmission of information. Economic resources would be wasted through efforts to minimize the ‘bit tax’. Further, it would also be counterproductive in that it burdens e-commerce and its productivity .For example, software companies might continue to ship magnetic tapes and cartridges rather than use the more efficient method 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 electronic transmission does not reflect true value. They argue for taxing electronic transmission according to bits rather than value, as is the case under a value-added tax. Experience has shown that when prices are set by social planners rather than by the operation of the free market the loss of economic efficiency can be enormous. There is no reason to believe that the marketplace cannot adjust pricing systems to better align prices with 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 of the Internet would not be a desirable goal. It is premature to conclude that existing taxes cannot be successfully adjusted to accommodate technological innovations. The solution to these problems lies not in new taxes, but rather in technology itself. What is required is clearly defined tax compliance requirements, reasonable adjustments to existing 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 for ensuring the continued effective administration and collection of consumption taxes'.[48] The endeavour is to be undertaken in a spirit of cooperation and consultation among governments and affected industries. The OECD's agenda focuses in the main on consumption taxes on international B2C services. The OECD Working Party on Consumption 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 and might be suitable and workable in different circumstances. To evaluate the suitability and workability each mechanism the Working Party considered three criteria. The first criterion was the feasibility of implementation. Does the mechanism have a chance of implementation? The second criterion was the compliance burden. The costs for business of implementing and applying the mechanism should not be so high that it would prevent compliance and encourage avoidance and evasion. The third and final 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, also referred to as Reverse Charge. Under a self-assessment system, recipients would be required to determine the tax owing on imports of digital supplies and to remit this amount to their domestic tax authority. While this mechanism is very suitable for transactions where the recipient is a business, it is unpractical for transactions where the recipient is a private consumer. This mechanism, to a smaller or larger extent, is used for business-to-business transactions in most OECD-countries. It has proven feasible and effective and carries a low compliance and administrative burden. For transactions involving private customers, however, it is highly ineffective. Taxing a private customer for the digital supplies he had received would be very burdensome on both the consumer and the tax authority in terms of compliance and control. Taxing private individuals using this mechanism also delivers high compliance and administrative costs. Asking consumers to keep books and to control those books is going to be wasteful and burdensome on both taxpayers and tax administrations. This means 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 digital supplies to register in a jurisdiction in which he has made sales. After registration, the seller will be required to charge, collect, and remit the consumption tax to the country in 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 then have to charge and collect Canadian consumption tax and remit the tax to the Canadian tax authorities. From an administrative point of view, registration of non-resident suppliers will for the most part be feasible and effective. Since the registration of non-residents will not directly require bilateral or multilateral arrangements, this mechanism is relatively easy to implement[49] . Difficulties arise in terms of identifying non-resident suppliers as well as in imposing registration requirements and enforcing obligations on non-residents. This mechanism can therefore increase the costs for tax administrations and for businesses. This will be particularly true for businesses making supplies in multiple jurisdictions. Without international co-operation, there will also be a risk that businesses will not comply. In the absence of international co-operation, this mechanism depends on the voluntary compliance 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 Source and Transfer system. Under this system, a business will collect consumption tax on sales 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 the revenue authority of the country of consumption. This system shares some features with the registration system. A major difference of course being that under a system of tax at source and transfer, suppliers of digital supplies will not be required to register abroad. Businesses can handle their foreign consumption tax responsibilities with their national tax authorities. However, this mechanism requires tax revenue to be transferred from one tax jurisdiction to another. This means that considerable international agreement will be needed, which would make this mechanism difficult to implement. The significant compliance cost associated with the registration mechanism will be largely avoided by the tax at source and transfer mechanism. This however will be replaced by significant administrative costs that come with the required international co-operation.

The fourth option the Working Party considered was an entirely new system where third parties will be enlisted to collect consumption taxes on transactions between recipients and suppliers of digital supplies. A Trusted Third Party will monitor the transactions between buyers and sellers and charge the buyers consumption taxes and remit 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, both compliance and administrative costs would be kept to a minimum. If simplicity is the guiding 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 wants to deal with bodies that have a good commercial reason to be helpful. If a business only needs to deal with one third party, but can choose between several competing third parties based on quality of service that is likely to produce the best outcome all round. Much of the success of the mechanism depends on the legal relationships between businesses, third parties, and tax authorities and will need to be correctly structured. The feasibility of this mechanism, however, is a point of concern. Shifting the onus of collection onto a commercial organisation is troublesome. Today, many consumption taxes are collected by businesses that do not receive compensation for this imposed task. Granting a fee for the collection of consumption taxes in the field of e-commerce makes it difficult to deny an allowance in other fields. Ideally, tax collection 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 Party studied was Technology driven options. Various technology-based and technology-facilitated options were debated. One such approach involves the use of tamper-proof software 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 possible mechanisms. As these mechanisms are still to be developed, it is possible to incorporate requirements for feasibility and effectiveness into the development programs. Doing this will produce mechanisms that not only carry low administrative and compliance costs but also can be easily implemented. Currently such technology driven collection mechanisms are being developed. They will probably be available in the medium term.

However, none of these methods is perfect, but several of them can be used together to provide a reasonable level of assurance. The need for simplicity provide some guidance 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 a high degree. The WP9 paper argues that technology can support any part of the overall compliance model[50] . However, one can go further and say that technology-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 give tax 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 mechanism for B2C transactions, however, they also acknowledges that this system has its shortcomings. Even so, the OECD remains confident in its general direction. The OECD’s insists on tax neutrality between electronic and conventional commerce and insists on protecting each country’s local tax base. This requires of member countries and their tax authorities a very strong level of administrative cooperation and the organization 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 years endeavours have made one thing certain: the solution is not going to come only from achieving the right principles, it will have to be supported by technology. So, what happens next? Does this unprecedented phenomenon of e-commerce necessarily argue for the creation of a new tax system? Does it require simplification techniques in compliance and administration areas? Most scholars argue that the creation of a new tax system is perhaps a far-fetched thought. However, in an attempt to resolve taxation issues,'out-of-the-box' thinking is a good first step. Consideration should be given 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 collected to the customers' countries, neutrality and the tax base will be protected. A solution along these lines might be feasible within an economic union such as the European Union[51] or the United States,[52] but the odds of a looser economic grouping such as ASEAN devising a similar arrangement are tiny and the chances of a move to a multilateral treaty applying generally are virtually non-existent. Even if such a system could be established, it would quickly lead to the establishment of virtual distributors located in low consumption tax jurisdictions, unless the multi-lateral agreement was accompanied by the universal harmonisation of consumption taxes, a completely unrealistic prospect.

It has not been the aim of this paper to suggest a solution however; any proposal will have to be flexible and dynamic and should have the capability to adapt according to the 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 the necessary elements that are useful for the development of e-commerce as a successful business process. Microeconomic theory predicts, [53] ceteris paribus, that consumers will 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 any potential price reductions achieved from trading on-line will be more than offset by the taxes imposed, thereby rendering e-commerce a fad of the 1990s. Accordingly, in order 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-commerce transactions must be less than or equal to the same amount of tax that the consumers would otherwise face if the consumers purchased the identical goods or services from traditional brick and mortar retail establishments in their home-state. The inevitable conclusion is that in order to satisfy both the legal and economic constraints, consumption tax rates applied to e-commerce transactions must be apportioned. This means that the compliance burden on sellers must be kept to a minimum. From a buyer’s point of view it must also provide the environment where buyers will be able to comply with minimum effort. It can be suggested here that such a proposal must be capable of using the existing workflow and the technology. However, creation of such a system will require the refinement of administrative techniques, particularly in respect to collection and auditing methods. In particular, attention must be directed to electronic information gathering and development of reference techniques to identify taxpayers beyond any reasonable doubt. The best method in the short term may not be the 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, human beings 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,’ Fundamental Tax Reform,

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

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

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

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

[6]Owens, Jeffrey (1997) 'The Tax Man Cometh to Cyberspace', paper presented at the Harvard Law School International Tax Program Symposium on Multi-jurisdictional Taxation of Electronic Commerce, April 5, 1997

[7]Supra Note 2

[8]Basu, Subhajit (2004) 'Implementing E-Commerce Tax Policy', British Tax Review, 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 Tax Administration' Paper presented to the United Nations Ad Hoc Group of Experts on International Cooperation in Tax Matters in Geneva, Switzerland, on September 12, 2001 pp 16-18

[11]McLure, Charles E Jr (1997) ‘Taxation of Electronic Commerce: Economic Objectives, Technological Constraints, and Tax Laws’, Tax Law Review, Symposium on Taxation and Electronic Commerce

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

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

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

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

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

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

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

[19]Goolsbee, A. (2000) 'In a World without Borders: The Impact of Taxes on Internet Commerce', National Bureau of Economic Research (NBER) Working Paper No. 6863, Cambridge, MA

[20]Congressional Budget Office, 2003, 'Economic Issues in Taxing Internet and Mail-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 for Electronic Commerce,' International Tax and Public Finance, Vol. 10, pp. 79-97

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

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

[25]As reported by Cyber Atlas, ‘Online Holiday Shoppers to Triple’ 9 November 1999, available at

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

[27]OECD, ‘The Economic and Social Impact of Electronic Commerce: Preliminary Findings 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 not encouraging 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 case for the past two years major world economies were slowing down. It would appear in coming years that ‘bust’ of e-commerce companies during this period was exception rather 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 Will Be 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 of production and distribution needs to be fully credited against output tax

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

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

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

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

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

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

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

[41]Deloitte & Touché LLP (1996) ‘Consumption Tax Issues Briefs,’ Fundamental Tax Reform, available at <>.

[42]Eggermont, Tino (1998) ‘The Commission’s work programme for the gradual introduction of the new common VAT system,’ European Commission, 1998, Available at <>.

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

[44]Whalley, J. (1979) 'Uniform Domestic Tax Rates, Trade Distortions and Economic 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 annual Meeting of the Club of Rome, November

[47]Available from <>, published in July 1999

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

[49] OECD (2001) 'Taxation and Electronic Commerce: Implementing the Ottawa Taxation 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 European Commission" 4, VAT Monitor vol. 10, p 156

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

[54]Rosen,Harvey S(1999)Public Finance, (5th Ed., 1999) Marginal Analysis p. 526.



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