Tag Archives: permanent establishment

Taxation of Ecommerce Transactions: Spotlight on Russia

The Russian ecommerce sector will continue to experience significant growth, whether serving the B2C or B2B markets.  And Russia has much to gain by supporting a robust ecommerce marketplace, for example, broadening the labour market for skilled workers and increasing the tax base,  Absent specific tax legislation, existing tax laws will be applied to ecommerce transactions.  Yet existing tax laws are often inadequate to address the new business and transaction models arising from ecommerce transactions.

The issues arising from the B2C market and the B2B market are clearly different, as are the type of taxes that may be imposed.  First, income tax imposed on profits arising from the ecommerce transactions, and second, in the case of B2C transactions, VAT.

The application of the existing framework for income taxation on transactions taking place between parties where both are located in Russia is identical to a transaction occurring without the benefit of the internet.  With increasing ease, companies can target consumers in any country, their reach is borderless.  In order fall subject to Russian profit tax, a foreign company must have a permanent establishment in Russia  A permanent establishment is deemed to arise where there is a remote place of business through which the foreign enterprise carries on business on a regular basis.  Although applied primarily where there is a building or other structure, or in the absence of a specific business location, where the business has employees.

In December 2010, the Moscow State Commercial Court held that a representative office of Bloomberg LP, through which employees gathered data which was entered into a database, access to which was subsequently sold through a UK office, constituted a permanent establishment.  Given this ruling, it is not unlikely that the same court would characterize a server located in Russia as a permanent establishment.  The permanency of a server, owned by a foreign company, that directs, stores, and filters customer traffic and through which transactions are completed will not be ignored by tax authorities.  Such characterization would follow similar rulings in other countries.

In terms of VAT, there are no specific tax rules that impose VAT on internet transactions.  Existing VAT legislation can be easily applied to an ecommerce transaction where both the buyer and seller are located within Russia.  VAT, an indirect tax, is generally imposed on goods at the place of consumption, but for services the imposition of VAT will depend on the place of supply.  This is perhaps an overly broad explanation, the Russian Tax Code does makes a distinction between certain types of services and the imposition of VAT on services is reliant on such distinction.  However characterized, foreign businesses are not required to collect and remit VAT.  Since the burden falls on Russian based businesses, then, a disparity arises.  Other countries, including the US have been grappling with this same issue.  Amazon.com is a prime example, it is not required to collect and remit sales tax in the state where the consumer is located if it has no physical presence in that state, providing an advantage over its competitors.  The question remains, in an ecommerce transaction where services are being supplied, such as, access to internet services, including, digital products, is the “place of supply” where the consumer is located or where the server or service provider is located.  This is an area of significant debate, one which will not end soon.  As ecommerce expands its reach, lawmakers will resolve some of the ambiguities present in application of outdated laws.  Until then, be aware of where the ambiguities create the biggest risk for your ecommerce business.


Taxing the Internet: The Rise of a Digital Media Tax

For a number of years, France, and others, (remember, the byte tax originally proposed by the Netherlands) have been raising the idea of a digital media tax.  We can all appreciate that the internet has revolutionized the way in which business is conducted and revenues are generated.  Gone at the static business models with very identifiable revenue streams.  Current tax laws are inadequate to capture the value digital activities being undertaken by multinational technology and digital media companies are creating.  To address this issue in a more formal way, France, in early 2013, commissioned a study on the taxation of the digital economy.  And more recently the European Commission has begun a study of its own by appointing a committee of experts to look at ways to tax internet companies.

The perceived, and currently untaxed, value created by internet companies is the difference between what is taxable without the presence of a permanent establishment (very little, if anything) and the revenues or value arising from user generated data and information.  Under the permanent establishment concept, present in most double tax treaties, a company that has no physical presence in a particular country is not subject to income tax on income arising from customers or users located in that country.  Internet companies are free to locate primary revenue generating activities in low or no tax jurisdictions, and use double tax treaties and other optimization methods to reduce worldwide income tax.

One justification for taxing the internet, was set out in the French commissioned report “L’Age de la Multitude” which pointed out that in order to reach its users, collect and market the data, companies like Google, Apple and Samsung, for example, rely on the infrastructure built by local public investment.  These internet companies, use the infrastructure and local technology networks without participating in its costs, by creating jobs or otherwise contributing to the local economy.

The question being raised, is whether companies profiting from the user data collected should pay tax on that value created, where it is created.  India may be have taken the first step to creating a system to tax the internet, by imposing a duty to pay income tax on companies that have an economic nexus rather than a physical one.  Applying this concept, a company who has collected, combined and monitored users’ personal data would pay a tax on the value of that information.  Could this conundrum be resolved by requiring internet companies to register in each country in which they collect personal information from its users?  It must abide by local data protection laws anyway, registration could be imposed by minor amendments to data protection laws; or perhaps redefine the double tax treaty concept of permanent establishment to trigger a permanent establishment each time a user’s data is collected by the internet company.

There will be many more studies, reports, discussions and negotiations around how to tax the internet.  Although I would not expect imminent across the board acceptance of a tax on digital media, I do expect that a few countries will push to amend local tax laws to capture some of this value within its borders. Watch for the results of the EC study, expected to be out mid-2014, and further steps to be taken by France who may be the front runner in imposing a tax on internet companies.


Implications of the Supreme Court’s Refusal to Hear Nexus Appeal

On December 2, the Supreme Court of the United States declined to grant writ of certiorari filed by two online retail giants, Amazon.com LLC and Overstock.com, Inc.    The broad issue at hand, is whether online retailers must charge, collect and remit state sales tax in states where their customers are located, but where the online retailer has no physical presence.  The issue, although not new, could have quite an impact on online retailers worldwide.

In 1992, the Supreme Court held that a physical presence, in the state where the customer is located, is necessary to establish a nexus between a company and the state for the purposes of sales tax.  The State of New York, concluded, more recently, that sellers who sign up for the Amazon affiliate program create that nexus.  This is a tenuous conclusion since the sellers are, in fact, simply another Amazon.com customer; the product purchased is access to Amazon retail customers through a link on a website.  Amazon.com has no control over the website, does not employ the seller or have any trappings of a typical office in that state.  The Supreme Court’s refusal to hear the appeal could be taken as a broad expansion of the state’s power to tax.  This could have a ripple effect for online retailers located in other countries.  The cost of having to charge, collect and remit sales tax to each of the 52 states will create a significant hardship for small to medium sized companies.

The physical presence/nexus concept is not different from the treaty concept of permanent establishment.  U.S. online retailers selling into other countries have not had the burden of charging, collecting and remitting VAT or other tax on sales, if they had no permanent establishment in that country.  The question will now be whether the physical presence of a sales affiliate program similar to the Amazon.com will trigger a permanent establishment, not simply for the purposes of VAT, but also income tax.


Top Five Considerations When Structuring Your International Business.

Moving into foreign markets can be costly, but expansion can be very profitable and necessary. With astute planning your business can avoid pitfalls that will undermine the overall economy brought by the structure.  Be prepared to examine all possibilities.  Think long term, how will the business grow over time, what markets will be the most profitable, then make informed and considered decisions. 

1.  Tax Havens vs. High-Tax Jurisdictions
While it might seem logical that inclusion of corporate entities, in your overall structure, in countries that impose no income tax can achieve the greatest tax economy, it is not necessarily true.  Using high tax jurisdictions with a network of treaties can often achieve better results.  The use of tax-effective structures in, for example, European countries and effective use of tax optimization principles, including correct transfer-pricing, group taxation regimes and hybrid structures, all of which are not deemed as tax avoidance or abuse of treaty rules in their host countries can provide for an overall more efficient structure.  This is true even considering the costs of creating such a structure.

2.  Anti-Avoidance Rules
Avoidance and/or minimization of taxation is of growing importance to many jurisdictions.  To address this concern many countries have enacted anti-avoidance rules, designed to prevent taxpayers from creating business structures with no purpose other than obtaining tax benefits.  Anti-avoidance rules generally deny tax benefits, including expensed deductions, tax credits, exemptions, and lower tax rates, if the transfers are made through a network of companies with no connection to the business activity of the taxpayer.  The underlying transaction being deemed artificial with no commercial goal or purpose.  Carefully consider implementation of a business structure from the standpoint of its connection with the business activity of the taxpayer and the existence of a commercial purpose.

3. Transfer Pricing
The transfer price is the price at which related companies transact business with each other, including the supply of services, supplies, product or labor.  Transfer pricing is a valuable tool for cross-border tax planning. Tax authorities worldwide carefully scrutinize transfer prices between related companies more than any other pricing arrangements.  Many countries allow related companies to set prices for transactions between them in any manner, but to the extent those prices are not equivalent to an amount an unrelated third party would charge for the same or similar services, the tax authorities adjust the transfer price and may impose penalties.

4. VAT
Value-Added Tax (VAT) and any other sales and/or use tax is complex and challenging and can result in significant, and often, unrecoverable costs.  In planning a business structure in addition to the general scope of VAT aspects, take into account VAT treatment of supply of goods and services in both the supplier and customer’s country.  Avoid structures which result in VAT payable both in supplier’s and customer’s country of residence, and whether there is any VAT credit.  The VAT liability for online transactions is still in flux, changes in legislation regarding whether the delivery of services or intangible property delivered over the Internet is VAT-able in countries where the vendor has no Permanent Establishment much be watched closely.

5. Permanent Establishment
Once a business has created a physical presence (“Permanent Establishment”) in a particular jurisdiction it is subject to income tax in that jurisdiction.  A Permanent Establishment will be found where there is a fixed place of business.  A number of countries have determined that a single server owned by a company and located that jurisdiction creates that taxable presence.  Thus, if having a server in that country is desirable, consider leasing a server or using a local service provider.  The risks of recognition of PE have significantly increased since the introduction of new rules regarding agency and service PEs.   Such rules have not yet been tested and create uncertainty.