In a move that provides more clarity on a thorny issue surrounding legal jurisdiction in cyberspace, a key group of the worlds most developed nations has agreed on one of the primary conditions under which countries can tax profits from electronic commerce.
The Organization for Economic Cooperation and Development — of which the U.S. and most European countries are members — announced last week that it reached consensus on when certain e-commerce activities constitute a permanent establishment in a foreign country. Determining whether a foreign company has a permanent establishment is one of the key principles used to determine a countrys right to tax a foreign business.
Among the principles that OECD members endorsed was that neither a Web site nor a Web hosting arrangement constitutes a permanent establishment for tax purposes. The OECD also said an Internet service provider that may be providing services for a foreign business also cannot, except under "very unusual circumstances," be considered an agent of that business for purposes of determining whether it has a permanent establishment in a foreign country.
OECD officials said the agreement is an interpretation of existing provisions in the groups Model Tax Convention, which is used by both OECD member states and nonmembers as a benchmark when negotiating bilateral tax treaties.
The members agreed to apply the principles in dealing with other countries, so no new legislation is needed.
The OECD was less clear on whether a foreign government could use computer equipment such as a server as justification to tax a foreign business. The organization said this may constitute a permanent establishment if the functions performed by the equipment are a "significant" and essential part of the activities of a foreign business.
Jacques Sasseville, head of the OECDs tax treaty unit, said one or two countries have suggested that you do not need to have any form of physical presence to be taxed. In fact, India has reportedly tried to impose taxes on The Sabre Group, which provides electronic travel reservation services, claiming that the data traveling between the companys U.S.-based processing center and the computers of travel agents in India constitutes a permanent establishment. The OECD, however, appears to have rejected this concept.
"It conforms with traditional law," said Diane Cabell, supervising attorney of the clinic program in cyberlaw at Harvard University Law School, in reference to the OECDs agreement. "It reflects what everyone thinks is a sensible" approach to this issue.
While business representatives were generally pleased that the OECD has provided some certainty in this area, they have reservations about how some of the exceptions may be implemented in practice.
It seems "like theyve moved in the right direction," said Bartlett Cleland, who handles tax issues at the Information Technology Association of America. But he added that the "devil is in the details."
Rules regarding permanent establishment are among the many issues the OECD is tackling concerning taxation and electronic commerce. It expects to issue a report later this year detailing areas in which OECD members have reached consensus.