OECD Takes on E-commerce Taxation

If only everything was as easy as the Marshall Plan for the OECD.

The Organization for Economic Co-operation and Development, the spin-off of the group which was chartered to ensure American aid to Europe after World War II was distributed properly to help rebuild the continent, is finding its most recent initiative coming under fire.

Last week the group announced that its 29 member nations had reached a consensus on a number of e-commerce taxation issues. Leading the way was the announcement that online transactions will not make a merchant liable to taxation in the country from which the purchaser of the goods and/or services is located.

But, what has caused a great deal of controversy with the announcement is the inclusion in the plan, which will make companies liable for taxes if they have a "presence" in multiple countries.

Under current international tax codes, a company can be forced to pay taxes in the country where the "permanent establishment" exists. The new guidelines set forth by the OECD say that the location of a server can constitute a permanent establishment.

Professor Geraint Johnes, a leading expert in international economics, says that using server location as the basis for taxes, could wind up with a different result from what the OECD has in mind.

"If it doesn't matter where in the world a server is located, firms will tend to locate them where taxes due are lowest," the Lancaster University Management School professor said.

The U.K.-based professor explained any international company is going to be exposed to more taxes.

"A server that is owned or rented by a company is deemed to be a permanent establishment," he said. "But, if the company stores data or software on a server that it does not itself own or rent, then it is not liable to this tax."

Johnes said there are plenty of loopholes for companies to circumvent the tax.

"If a company rents space on a server in a second country, but does not rent the server itself, then no second country tax should be due," he explained. "But there are ambiguities here that are likely to be tested in the courts. What portion of a server's capacity needs to be rented out before you say that it is the server itself that is being rented? And what if the company rents a small amount of space on several servers?"

Johnes is not alone in his inhibitions about the new code. Gregory Adams-Tait, a Spanish businessman wrote a letter to the Financial Times expressing his opposition to the code. He said using server location to determine whether taxes can be levied is ridiculous.

"My company is no more located in those places than it is located in France when our telephone conversations are routed through a cable that runs across that county," he wrote in his letter.

Adams-Tait also paints a picture of servers being confined to countries with low taxes.

"The attempt to treat a computer as being a location of a business is a huge mistake for governments," he wrote.

While Johnes does point out the many ambiguities in the codes, he admits that they need to be implemented.

"The new codes are clearly necessary in order to prevent individual tax officers making up rules as they go along," he said.

So what does the OECD's code mean to the rest of the world? Many of the group's treaties are worked into law once it clears the proper channels of its member nations. Membership consists of the United States, the United Kingdom, Japan, Australia, New Zealand, Austria, Belgium, Canada, Denmark, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, Finland, Mexico, Czech Republic, Hungary, Korea and Poland.

Johnes points out that the U.S. stance will depend on congress.

"America negotiates its own tax treaties with international partners," he said. "So the OECD precedent would have to be adopted by the U.S. when renegotiating tax treaties with its partners."

Johnes doesn't see any problems with the U.S. adopting the new policy.

"This will take time, but will happen," he said. "The U.S. has in the past consistently adopted the OECD model."

Some Internet junkies fear multi-national legislation like this is the beginning of mass regulation for the Web, but Johnes is quick to discount those fears.

"All these rules are doing is defining a tax base by clarifying what a permanent establishment in a given country actually means," he said. "Effective international regulation of the Internet in terms of content would be an altogether more ambitious project. It would require every country in the world to agree on what regulation is needed, and it would also require the legal processes in every country to act rapidly."

The chances of all those different elements coming together to agree on such a wide range of topics makes it hard to believe for Johnes that any widespread regulation will happen in the near future.

"Any such regulation is unlikely ever to be a challenge to individual freedoms, because it would only take one country to refuse to regulate to make the whole edifice of regulation unsustainable," he said.

In 1947, the Organization for European Economic Co-Operation (OEEC), was chartered with the task of ensuring the Marshall Plan was carried out to its fullest extend. Now in 2001 the OEEC's spin-off, the OECD has accepted the challenge to regulate the way international taxes are owed and paid for an industry which knows no boundaries.