Article, How e-commerce alters the consumption taxes with respect to the characteristics of a good tax

Global E-commerce Taxation

Benjamin M Musau, Lawyer, Nairobi, Kenya

This article discusses how e-commerce alters the consumption taxes with respect to the characteristics of a good tax: neutrality or efficiency, vertical equity, horizontal equity, revenue potential or stability, simplicity, and administrative feasibility.
The manner in which e-commerce alters the consumption taxes with respect to the characteristics of a good tax are discussed in detail by Charles Scott, Frederick Derrick, and Norman Sedgley in an article entitled Consumption Taxes in the Internet World[1].  The main alterations are  as follows:
 
Neutrality or Efficiency
 

• A neutral tax would not impact the choice of process, the agent, or the type of product purchased.  A perfectly neutral consumption tax taxes all final consumption at a uniform rate, leaving relative prices unchanged.
• Narrow sales tax bases and varying tax rates make the two taxes non-neutral, affecting tax-included price ratios, and encouraging tax-induced consumer adjustments (goods, processes, or agents).
• Tax code differences across taxing jurisdictions further erode tax neutrality and fairness of the taxes.
• Arguments for special treatment of e-commerce violate neutrality since the process would impact taxability.
• For example, if software is digitized and delivered online, neutrality and efficiency require that the good (software) be taxed at the same rate as its physical counterparts packaged for sale in a retail store.  A neutral tax system must treat these options identically to maintain a level playing field between e-commerce and traditional commerce, accounting for the difference in costs of distribution.

 
Vertical Equity:
 

• Digitization of any aspect of an electronic transaction impacts vertical equity since –income consumers are more likely to have Internet access and e-commerce spending is more unevenly distributed than spending in the U.S.  This provides higher income households a greater chance to avoid tax[2].

 
Horizontal Equity
 

• Digitization of the product has the greatest implications for horizontal equity.  If digital goods are electronically distributed, the tax can be avoided in cross-border transactions.
• In theory, process differences between traditional commerce and e-commerce are inconsequential for the sales and use tax.
• In practice, difficulties in collecting the use tax lower its horizontal equity.

 
Revenue Potential or Stability
 

• If e-commerce is generally classified as a service or given a special exemption, sales tax bases relative to total spending will narrow and consumption tax revenue growth will slow.
• These adjustments enhance existing flaws in the sales tax system.
• Digitization of the process and agent facilitates cross-border transactions and creates the opportunity to exploit loopholes in the global tax structure.

 
Simplicity
 

• In the U.S., the large number of exemptions enacted over an extended period has created complex tax codes for the over 7,500 taxing jurisdictions.  This complicates the collection of taxes, not only within a jurisdiction, but also exponentially in an interstate or global context.
• This complexity issue will decrease in time as computers take more detailed cross-jurisdictional transactions.
• The relative simplicity of a uniform definition of tax base and rates of the VAT, at least with a particular country, combined with tax coordination within the EU, and the smaller number of jurisdictions, puts the VAT in a better position to address e-commerce growth.
• Timing of sales tax revenues is affected by different accounting methods.

 
Administrative Feasibility
 
Administrative feasibility issues fall into 3 categories:
 

• Responsibility for collection;
• Ease of collection;
• Ease of monitoring.

 
Sales tax and VAT collection and remission are the legal responsibility of the seller except for inter-jurisdictional direct sales.
 

• With a sales tax the seller is responsible for collecting and remitting the tax if the seller except for inter-jurisdictional direct sales.

• In Quill v North Dakoto, 112 U.S. 298 [1992], the court ruled that Quill was not responsible for collecting North Dakota sales tax because its physical connection with the state is through a common carrier for its products.  The court appears to have left open the possibility that this ruling does not apply to all types of interstate commerce and each case should be heard on its own merits.

• In Oklahoma Tax Commission v Jefferson Lines. 115 S. Ct. 133 [1995], the court ruled nexus was established if agreement, payment, and delivery take place in one state.  This redefinition of nexus – the states’ autonomous attempts to solve the inter-jurisdictional commerce problem – may only shift the collection responsibility from the government to firms engaged in cross-border transactions.

 
The VAT is always collected by the vendor.  The inter-jurisdictional nature of the transaction makes the tax refundable to the external purchaser but places the refund burden on the purchaser.  This inherently decreases the administrative impact of the inter-jurisdictional transactions.
 
 
References:
 

1. Selected Tax Policy Implications of Global Electronic Commerce.  Department of the Treasury, Office of Tax Policy, November 1996.  http://www.treasury.gov/resource-center/tax-policy/Documents/internet.pdf.  Retrieved April 26, 2011.
2. Electronic commerce: A Report of the Steering Committee (2006).  Federation of Tax Administrators.  http://www.taxadmin.org/fta/pub/ecommerce.pdf.  Retrieved April 26, 2011.

 
Benjamin M Musau
 
April 26, 2011

Dr. Benjamin Musau

I am a Kenyan Advocate and the Managing Partner of B M Musau & Co., Advocates, a position I have held since 1999. My work encompasses regulatory reforms, reduction of administrative burdens, the structure of business entities, joint ventures, acquisitions, banking, foreign investment and other general corporate areas