Are There Any Tax Havens in Electronic Commerce?

• Publication year: 2001
• Citation: Vol. 3 No. 2001

Michelle L. Prettie⁰

INTRODUCTION..................................................................... 2

PART ONE - CURRENT INTERNAL REVENUE CODE PROVISIONS ................4

"Effectively Connected"....................................................................5

United States Trade or Business....................................................................6

"In the United States".................................................................... 7

U.S. Trade or Business by Imputation....................................................................9

Impact of Tax Treaties - Permanent Establishment Concept... 10 No Tax Treaty....................................................................12

PART TWO - POSSIBLE GUIDANCE....................................................................14

Overview....................................................................14

Computer Servers....................................................................15

Internet Tax Freedom Act....................................................................17

Treasury Report18

organisation for Economic Cooperation and Development............. 22

International Tax Planning Options............................................26

Server Located Outside the United States..............................................26

Server Located Within the United States..............................................26

Guidance to Avoid a Taxable Presence in the United States ........27

Locating in a Tax Haven Country..............................................28

Other Tax Authorities' Approaches..............................................29

Web Server Does Not Create a Nexus in Virginia..............................................29

Japan..............................................29

United Kingdom..............................................30

Australia..............................................30

Singapore..............................................31

CONCLUSION..............................................32

Introduction

Entertainment division of Tax and Legal Services. The author wishes to thank Marc Randazza.

"The digital transaction poses a variation of the old philosophical conundrum: if a tree falls in the forest and no one hears it does it make a sound? In the electronic commerce context, the issue might be posed as follows: if all [ ] value is created in state R, but all the customers that determine value are in state C, where is the income generated?"¹ The ability of a state to claim its share of income from an enterprise engaged in e-commerce depends upon its ability to establish that the entity has a sufficient presence in the state to justify the exercise of taxing authority. under most tax treaties this nexus is defined as "permanent establishment," or fixed place of business. In the absence of a treaty, however, the less liberal "taxable presence" standard applies.

E-commerce sales do not require a fixed place of business in foreign countries since consumers can order goods by accessing the seller's website over the Internet. As such, e-commerce permits a foreign company to engage in extensive transactions with U.S. customers without entering the United States. Although such a company is clearly engaged in a trade or business, questions will arise as to whether he is engaged in a trade or business in the United States. one of the main elements of any e-commerce business is the Web server and where it is located - even if it is operated from another country.

The scope of this paper is limited to whether a Web server located in the United States "owned" by a foreign tax haven company will cause income tax liability in the United States when there are no applicable treaties. Does the existence of a computer server in a foreign jurisdiction constitute taxable presence? Part One discusses the current Internal Revenue Code provisions applicable to the taxation of foreign companies and related cases. Part Two discusses possible guidance for taxation of these foreign companies engaging in e-commerce through the use of a server located in the United States and international tax planning options. Part Two also discusses the approaches of other tax authorities on whether a server constitutes a taxable presence.

Part One - Current Internal Revenue Code Provisions

Under Internal Revenue Code §882(a)(1), a foreign corporation engaged in a trade or business within the United States is taxed at graduated rates only on income effectively connected with the conduct of a trade or business within the United States.² A corporation is a domestic corporation if created or organized in the United States, organized under the laws of any state, or organized under the laws of the United States.³ Thus, a foreign corporation is a corporation that is not created or organized under federal or state law. However, the question remains whether an entity is a corporation in the first instance. Corporations include "associations, joint-stock companies, and insurance companies."⁴ Certain domestic and foreign business entities are automatically characterized as corporations and known as "per se" corporations.⁵ A business entity that is not a "per se" corporation can elect its classification for federal tax purposes.⁶ If an entity fails to make an election, the regulations contain certain default provisions that are effective depending on the liability of an entity's members.⁷

"Effectively Connected"

A foreign corporation engaged in U.S. trade or business during the taxable year is taxed on a net basis on its taxable income which is effectively connected with the conduct of that trade or business.⁸ "All income, gain, or loss from sources within the United States shall be treated as effectively connected with the conduct of a trade or business within the United States."⁹

United States Trade or Business

Although the term "trade or business" is not defined in the Internal Revenue Code,¹⁰ the Code refers to profit-seeking activities.¹¹ The concept was developed in the context of conventional types of commerce conducted through identifiable physical locations. Whether a foreign corporation is engaged in U.S. trade or business depends on the facts and circumstances of each particular case.¹² The determination is left, therefore, "primarily to the legacy of interpretation of the concept in the context of other provisions of the Code and a modest accumulation of judicial decisions and rulings interpreting the term in the international context."¹³ Generally, a U.S. trade or business exists if the activities are "considerable, continuous, and regular."¹⁴ Isolated or sporadic transactions should not constitute U.S. trade or business.¹⁵ Personal services performed within the United States are included.¹⁶ Therefore, "being engaged in a trade or business in the United States is a threshold requirement for the taxation of active business income earned by foreign persons."¹⁷

"In the United States"

The straightforward analysis involved in determining whether a foreign entity is engaged in a trade or business stands in marked contrast to the question of whether it is so engaged "in the United States." In Piedras Negras Broadcasting Co. v. Commissioner, at question was whether the taxpayer was conducting a trade or business in the United States.¹⁸ The case involved a foreign Mexican corporation that operated a commercial radio station where about ninety-five percent of the income was from American advertisers, and about ninety percent of the listener responses to the advertisers came from the United States.¹⁹ The taxpayer had no physical presence in the United States; the necessary plant and equipment for broadcasting the various programs put on the air were located in Mexico.²⁰ The Court held that a foreign person not physically present in the United States, who merely solicits orders from within the United States only through advertising and then sends tangible goods to the United States in satisfaction of the orders, is unlikely to be engaged in a trade or business in the United States even though such a person is clearly engaged in a trade or business.²¹ The Court held that physical presence was lacking because the source of the income was the act of transmission.²²

United States v. Balanovski also involved the question of whether the taxpayer was conducting a trade or business in the United States.²³ The taxpayer was an Argentine citizen who came to the United States to obtain offers for the sale of trucks and other equipment.²⁴ Upon receiving the bids, he would submit them at markup to the Argentine government.²⁵ He was in the United States soliciting orders, inspecting merchandise, making purchases and completing sales.²⁶ While engaging in these "numerous transactions....[h]e was obviously making important business decisions."²⁷ The level of the taxpayer's activities convinced the Court that the taxpayer was engaged in a trade or business and that the trade or business was conducted in the United States rather than in Argentina.

U.S. Trade or Business by Imputation

A foreign company who is not directly engaged in U.S. trade or business nevertheless may be deemed to be engaged in U.S. trade or business as the result of the activities of an agent. The determination will depend upon the functions and activities performed by the agent in the United States on behalf of the otherwise absent foreign person. "The cases hold that profit-oriented activities in the United States, whether carried on by the taxpayer directly or through agents, are a trade or business if they are regular, substantial, and continuous."²⁸

In Lewenhaupt v. Commissioner, the taxpayer, a Swedish resident, was the owner of U.S. real property managed by a U.S. agent.²⁹ The agent was given broad general powers of attorney to buy and sell real property, execute leases, rent properties, collect rents, pay taxes and mortgage interest, and arrange for insurance.³⁰ These activities were...