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Selected Tax Policy Implications of Global Electronic Commerce

Department of the Treasury Office of Tax Policy

November 1996

This paper provides an introduction to certain federal income tax policy and administration issues presented by developments in communications technology and electronic commerce. This paper is a discussion document, designed to elicit views on the issues presented as well as suggestions as to solutions for new problems. This paper is neither intended, nor should be taken as an expression of the legal or policy views of the United States Government, including the Department of the Treasury and the Internal Revenue Service. In addition, no inference is intended as to current law.

Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended (the "Code").

This paper has also been posted on the Treasury Department's home page on the World Wide Web at http://www.treas.gov.

Comments on any of the issues raised by this paper should be addressed to: Joseph H. Guttentag, Senior Advisor to the Assistant Secretary (Tax Policy), Department of the Treasury, 1500 Pennsylvania Avenue, NW., Room 1018, Washington, D.C. 20220. Comments may also be submitted to Treasury via Internet e-mail to TAXPOLICY@do.treas.gov, with the subject line "technology issues." All comments will be available for public inspection and copying.

EXECUTIVE SUMMARY

New information and communications technologies such as the Internet are creating exciting opportunities for workers, consumers, and businesses. Information, services, and money may now be instantaneously transferred anywhere in the world. Firms are increasing their imports and exports of goods, services, and information as the costs associated with participating in global markets plummet, and they are forming closer relationships with suppliers and customers around the world. New markets and market mechanisms are emerging. Consumers can choose from a much broader range of goods and services, and "intelligent agent" software will soon give consumers an unprecedented ability to hunt for bargains.

These new technologies, particularly communications technologies including the Internet, have effectively eliminated national borders on the information highway. As a result, cross-border transactions may run the risk that countries will claim inconsistent taxing jurisdictions, and that taxpayers will be subject to quixotic taxation. If these technologies are to achieve their maximum potential, rules that provide certainty and prevent double taxation are required.

In order to ensure that these new technologies not be impeded, the development of substantive tax policy and administration in this area should be guided by the principle of neutrality. Neutrality rejects the imposition of new or additional taxes on electronic transactions and instead simply requires that the tax system treat similar income equally, regardless of whether it is earned through electronic means or through existing channels of commerce.

A major substantive issue raised by these new technologies is identifying the country or countries which have the jurisdiction to tax such income. It is necessary to clarify how existing concepts apply to persons engaged in electronic commerce. In addition, transactions in cyberspace will likely accelerate the current trend to de-emphasize traditional concepts of source-based taxation, increasing the importance of residence-based taxation.

Another major category of issues involve the classification of income arising from transactions in digitized information, such as computer programs, books, music, or images. The distinction between royalty, sale of goods, and services income must be refined in light of the ease of transmitting and reproducing digitized information.

In the area of tax administration and compliance, electronic commerce may create new variations on old issues as well as new categories of issues. The major compliance issue posed by electronic commerce is the extent to which electronic money is analogous to cash and thus creates the potential for anonymous and untraceable transactions. Another significant category of issues involves identifying parties to communications and transactions utilizing these new technologies and verifying records when transactions are conducted electronically. However, developments in the science of encryption and related technologies may lead to systems that verify the identity of persons online and ensure the veracity of electronic documents.

Treasury invites comments on the issues raised by this paper as well as any other issues relating to electronic commerce.

Comments should be addressed to Joseph H. Guttentag, Senior Advisor to the Assistant Secretary (Tax Policy), Department of the Treasury, 1500 Pennsylvania Avenue, NW., Room 1018, Washington, D.C. 20220.

Comments may also be submitted via Internet e-mail to TAXPOLICY@do.treas.gov, with the subject line "technology issues." All comments will be available for public inspection and copying.

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Selected Tax Policy Implications of Global Electronic Commerce
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Posted November 27, 1996
Comment address updated February 1, 2000 (text of paper unchanged)