Internet transactions and PE issues.

• Author: Williamson, Donald T.
• Position: Permanent establishment

Foreign persons doing business on the Internet or through a website have the potential to conduct extensive commercial activities within the U.S. without establishing a permanent physical presence. This article examines how present rules on permanent establishments and effectively connected income should be applied to foreign-source income from Internet transactions and their adaptability to the taxation of e-commerce technology.

Foreign persons doing business on the Internet or through a website have the potential to conduct extensive commercial activities within the U.S. without establishing a permanent physical presence. Taxation of this type of electronic commerce (e-commerce) is generally subject to the same rules and principles that apply to other foreign-source income, such as effectively connected income (ECI) and permanent establishment (PE) requirements. However, these rules must be interpreted and adapted to take into account technological developments and to implement Treasury's stated policy of neutrality in currently rejecting any new or additional taxes on e-commerce.

An article in the April 2003 issue (1) described how present interpretations of the sourcing rules to conventional commerce should be applied to e-commerce transactions. This article examines how present U.S. rules on PE and ECI should be applied to foreign-source income from

Internet transactions and their adaptability to taxation of e-commerce technology.

PE and ECI

In general, Secs. 871(b) and 882(a) tax a foreign person like a U.S. person on U.S.-source (and certain foreign-source) income effectively connected to a U.S. trade or business. Thus, the U.S. taxes foreign persons at regular graduated rates on their net income effectively connected with the conduct of a trade or business within the U.S. (2) Similarly, under U.S. income tax treaties, a foreign person is subject to regular U.S. income tax rates on income connected with a U.S. PE. (3)

The U.S. has negotiated an extensive network of income tax treaties with over 60 nations, in which the concept of income attributable to a PE replaces that of income "effectively connected with U.S. trade or business" in determining whether a foreign person's income is subject to U.S. income taxation under the same rules that apply to a U.S. person. (4) In general, treaties define a PE as a fixed place of business through which an enterprise carries on transactions, with certain exceptions; this generally is a substantially higher threshold of presence than the Code requirements for engaging in a U.S. trade or business.

U.S. Trade or Business

Whether a foreign person is engaging in a trade or business in the U.S. largely depends on the person's physical presence in the U.S. Such presence is tested by the foreign person's (or its agent's) "continuous, considerable and regular" business activities in the U.S., including the performance of personal services. (5) In Inez deAmodio, (6) the Tax Court used both quantitative and qualitative analyses to determine whether the taxpayer's activities were sufficiently "continuous, considerable and regular" to constitute a U.S. trade or business.

Whether a foreign person's trade or business is engaged "in the U.S" is often a difficult question, particularly when that business is conducted electronically. In Piedras Negras Broadcasting Co., (7) a Mexican radio station that aimed its programming and signal primarily at a U.S. audience, earned foreign-source services income, because all income-producing activities (e.g., the radio...