Paper presented at the Southern African Accounting Association Conference held on 25 –

28 June 2008 at Emperor’s Palace, Johannesburg

PAPER - SAAA 09 [Non-refereed section]

Taxation and Electronic Commerce

by

Marcus Stelloh and Lilla Stack

Based on an essay submitted in partial fulfilment of the requirements for the

Postgraduate Diploma in Taxation

Department of Accounting

Rhodes University

December 2007

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TAXATION AND ELECTRONIC COMMERCE

Abstract Transactions conducted using the Internet have expanded dramatically in the past few years and countries and their governments have become concerned about the consequences that electronic commerce may have on their tax revenues. Because of this many organisations and inter-governmental agencies have met to try to design a solution that will be compatible with the systems of the various countries and achieve tax neutrality. A number of proposals were made and discussed to try to design a fair and efficient e-tax system. The proposed system that is ultimately adopted must consider different tax bases and systems in order to achieve this. In this research the impact of e-commerce on the imposition of income tax was briefly referred to and four different proposals for levying value-added tax or sales tax were analysed in order to compare the advantages and disadvantages of each and to determine which system would most adequately address the needs of e-commerce. Certain modifications and additions to the proposed systems have been suggested in order to satisfy the specific needs of the South African tax system, while still taking other countries’ tax systems into account. Using Amazon.com Inc. and Skype Technologies South Africa Limited as examples, it is demonstrated how the new amended system will work. It was found that the proposed systems and the system adapted to meet the South African needs would, with a few relatively minor changes to the Value-Added Tax legislation, be suitable for the purposes of imposing value-added tax on e-commerce transactions. Key words: electronic commerce; e-commerce; income tax; value-added tax

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CONTEXT

Conducting business using the Internet, electronic commerce, is fairly new and becoming

one of the largest industries in the world, with online retail sales expected to top 230

billion US dollars in 2008 (www.webzeit.com/site/citegeist/chronograph.html; 2007).

Appropriate tax legislation is needed that clearly establishes the tax principles to be

applied in taxing electronic commerce transactions. Electronic commerce (referred to as

“e-commerce”) takes place in a global environment, while each country imposes taxes

based on national legislation. Most countries enter into a network of Double Tax

Agreements with their main trading partners. In the case of South Africa the legislature is

empowered to do so in terms of section 108 of the Income Tax Act 58 of 1962. These

Double Taxation Agreements aim to prevent or mitigate the effect of taxing transactions in

both of the signatory countries and to provide mutual assistance in administering the

collection of taxes. Many of the agreements are based on the Organisation for Economic

Co-operation and Development (OECD) Model Tax Treaty, which does not specifically

address the problem of e-commerce.

The main problems arise with companies that trade online and sell goods in another

country, if the place where their permanent establishment is situated differs from their

online establishment. For example, a company XYZ Ltd may be incorporated in South

Africa (a South African resident by definition) and decides to establish its online business

through a server in America. If a product is sold to a customer in Germany who bought

the product via the new website, which country or countries may tax the South African

company’s business profit on the sale to the German customer? Is it America where the

website is hosted, or Germany because that is where the purchase was made, or South

Africa because that is where the product was produced and therefore where its permanent

establishment is situated (Chan, year unknown:15)?

This example illustrates how difficult it can be to apply the concepts of permanent

establishment, residence or source in order to tax the transaction. The present research

briefly discusses the problems of levying income tax on e-commerce transactions, but

deals mainly with the problem of imposing value-added tax (or sales tax) on these

transactions. To solve the problem of imposing these taxes, various proposals have been

made for taxing e-commerce. The first proposal is referred to as “Bit Tax” and applies the

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basis of telecommunication traffic to tax transactions. Every piece of data that moves

across the Internet carries interactive digital information that can be measured in bits. The

idea underlying this concept is to tax the flow volume of bit data in each country. Another

approach, known as “The European E-Commerce VAT Proposal”, deals specifically with

the Value-Added Taxation (VAT) problems. With this approach goods that are purchased

over the Internet are dealt with in the same way as services rendered. Another proposed

system is “The Clinton Administration’s E-Card Proposal”. This system proposes the

purchase by customers of electronic money in their home currency in order to purchase

goods or services online (Soete and Kamp, 1996). The last proposal, “The Software

Proposal”, tries to solve most problems by integrating certain software programs into the

supplier’s website. This integration leads to a nearly fully automated system that simplifies

any electronic transaction, where all that is required of the suppliers is to update the

software regularly (Atkinson and Court,1999).

One important issue that arises in an attempt to find a solution for Internet taxation is tax

neutrality. Simply because a good is sold over the Internet, the transaction should not

attract more tax or avoid the payment of tax. With e-commerce becoming one of the

biggest industries in the world, it is important that South African legislation follows

international trends and is updated in order to ensure accurate, fair and correct taxation

collections (Chan, year unknown). It is therefore necessary to find a model that works in

South Africa and at the same time addresses the global e-commerce taxation problem. It

is also important to differentiate between an actual good sold via e-commerce and a

service.

The present research considers each proposal and makes recommendations for ways in

which to adapt them to the South African value-added tax system in order to find a new

system that will work hand in hand with other tax authorities, so that each country gets its

fair share of tax revenue. To demonstrate the difference between the proposed systems,

Amazon.com Inc, which is an American wholesaler, and Skype Technologies South

Africa Limited, which is a South African subsidiary selling communication services, were

used as examples. The tax proposal adapted from two of the four systems was applied to

the e-commerce sales of each company to demonstrate how each country involved in the

transaction would receive the correct amount of tax.

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RESEARCH GOALS

The purpose of the research was to define e-commerce, discuss possible systems for taxing

e-commerce and explain how current tax legislation needs to be amended to accommodate

them, to establish which of the proposed systems for taxing electronic commerce is

suitable (if any) and to adapt the proposals in order to be compatible with the South

African value-added tax system, and to discuss the supply of a service and a product, using

Skype Technologies South Africa Limited (Skype) and Amazon.com Inc. (Amazon) as

examples in applying the taxation proposal for e-commerce.

ELECTRONIC COMMERCE, INCOME TAX AND VALUE-ADDED TAX

Electronic commerce, often referred to as e-commerce or eCommerce, is defined by the

United Nations Commission on International Trade Law as “commercial activities

conducted through an exchange of information generated, stored, or communicated by

electronic, optical, or analogous means …”. The Organisation for Economic Co-operation

and Development (OECD) simplifies this definition by stating that e-commerce is a

commercial transaction “involving both organizations and individuals, that are based upon

the processing and transmission of digitized data, including text, sound and visual images

and that are carried out over open networks (like the Internet) …” (www.oecd.org; 2007).

Thus any transaction using telecommunications can be defined as electronic commerce.

The main transactions that are carried out using e-commerce are the retailing and

wholesaling of physical goods and services, access to computer software and digital

information and online gambling.

Income tax

As the research is concerned mainly with value-added tax and e-commerce, only a few

observations are offered on income tax and e-commerce transactions. In seeking to

subject such transactions to income tax, the source of the income could be used as a basis

on which to levy the tax and the source would have to be determined. In the case of the

company XYZ Ltd referred to above, only one of three countries would be the source of

the income. The most common tests for determining the source of income (that is, the

originating cause) are:

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□ the place where the capital is employed (COT v British United Shoe Machinery

(SA) (Pty) Ltd, 26 SATC 163, and Liquidator, Rhodesian Metals Ltd v COT, 9

SATC 363);

□ the place where the taxpayer exercised his wits and labour (the activities test)

(Millin v CIR, 3 SATC 170, and particularly in relation to the buying and selling of

goods, CIR v Epstein, 19 SATC 1);

□ the place where the contract is entered into – where contracts are the essence of the

business carried on – (Boyd v CIR, 17 SATC 366).

In contrast to the principle of taxing income based on the source of the income, income

can be taxed on the basis of the place of residence of the person (both legal and natural

persons) earning the income, as is the case in South Africa. Where a Double Taxation

Treaty exists between South Africa and the foreign country involved in a transaction, the

treaty takes precedence over local South African tax law and determines which

jurisdiction may tax the income. The existing tax laws must, as far as possible, be used to

tax e-commerce transactions in order to maintain tax neutrality. With electronic

commerce it is very difficult, or even impossible, to apply the source principle in order to

link a transaction to a certain geographical location. In the example where the seller has a

website that is hosted in a country other than his home country and the buyer is situated in

a third country, the source could be any one of the three countries. This is one of the main

reasons why source-based income tax systems may be rendered obsolete by e-commerce

in the near future. From a business perspective the income may be subject to tax wherever

the business is resident. One of the tests for residence is the place of effective

management of the business or the place where its permanent establishment is situated. In

the case of e-commerce, it could be argued that the permanent establishment is where the

server is being hosted and administered for the website, or where the business has its main

operating activity such as its factory, or where the business decisions are made. In 2001,

however, it was agreed by the OECD that “a web site hosting arrangement typically does

not result in a permanent establishment for the enterprise that carries on business through

that web site” (www.oecd.org; 2007). This makes it easier to establish where a business’s

permanent establishment is situated. The Katz Commission (5th Interim Report of the

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Katz Commission, 1997) reported that South Africa is very likely to follow international

trends and, in particular, the principles set out by the OECD.

Value-added tax

In the case of value-added tax (VAT) as levied in South Africa (the Value-Added Tax Act,

89 of 1991) the problems posed by e-commerce are somewhat different. Although the

concept of “residence” has some relevance in relation to imported services and the

definition of “permanent establishment”, the levying of VAT depends on a taxpayer being

registered or being required to register as a VAT vendor in terms of section 23 of the VAT

Act (usually when sales exceed or are expected to exceed R300 000 during any year).

Section 7 of the VAT Act requires a vendor to collect and pay VAT on the value of the

supply of goods or services supplied in the course or furtherance of an enterprise,

calculated at 14 percent (or 0 percent, where goods or services are zero-rated). Persons

who import goods or services, irrespective of whether they are registered vendors, are

required to pay VAT on the goods or services.

An “enterprise” is defined in section 1 of the VAT Act as “any enterprise or activity

carried on continuously or regularly by a person in the Republic or partly in the Republic

in the course or furtherance of which goods or services are supplied to another person for

consideration . . . provided that, a branch or main business permanently situated at

premises outside the Republic, is a separate vendor, if it can be separately identified and

an independent system of accounting is maintained” (own emphasis). Thus, provided an

enterprise is situated at premises in the Republic, supplies of goods and services for

consideration (in cash or otherwise) are subject to VAT, unless specifically exempted.

Whether or not “premises” are the equivalent of a “permanent establishment” is not clear,

but the need for an independent system of accounting is one determinant. Whether a

server, together with its administration, would be considered to be a vendor, is also

questionable.

 

ELECTRONIC COMMERCE TAXATION PROPOSALS

Because e-commerce transactions cross international borders they are very likely to

conflict with the legislation and regulations of different countries and therefore a new tax

system for e-commerce needs to be adopted. The main aim of the system must be to be

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fair and tax neutral. This is to ensure that no hidden costs will occur in an electronic

transaction. Companies may not be willing to enter into e-commerce transactions if the

risk of paying more taxes is greater than bargained for. Specifically, two problems arise

with the taxing of e-commerce. It is very complex and in most situations it is not clear

what tax jurisdictions are involved in transactions. South African legislation and

regulations do not provide specifically for business transactions in the technological age.

This means that jurisprudential interpretation is non-existent or underdeveloped. Another

complicating issue is that different countries apply different tax systems. From this it

seems clear that a new system is needed that taxes electronic transactions fairly, quickly

and inexpensively in order to maintain the advantages of e-commerce. The OECD

(www.oecd.org; 2007) has stated that:

The emergence of electronic commerce heralds a major structural change in the economies of the

OECD member countries. It will affect the economic environment, the organisation of firms, the

behaviour of consumers, the workings of the government and most spheres of activity of

households and citizens… [s]overeign nations will need to come to terms with the global and

transfrontier nature of new networks and communications systems and establish a coherent,

predictable, legal and regulatory framework in which global electronic commerce can flourish…

The four main proposals aimed at addressing the problem of imposing value-added tax or

sales tax on e-commerce transactions are discussed below.

The “Bit Tax” proposal

The “Bit Tax” is a tax imposed on the interactive digital traffic that flows through the

Internet. The tax applies to all information and it would involve the introduction of "bit

measuring" equipment on all communication equipment, which is very similar to an

electricity meter. It enables consumers and users to monitor the volume of bits transferred,

whether they are transmitting by land-line or satellite. Whether a user accesses a personal

e-mail message or a company transmits an invoice or digital software, the tax to be paid

would be based only on the number of bits transmitted. The advantage of bit tax is its

simplicity. A flat tax rate is applied to the volume of bytes travelling through the Internet.

Telecommunications carrier companies, satellite networks and cable systems which

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operate the telecommunication lines will send the resulting tax revenues directly to the

governments (Chan, year unknown).

It sounds much simpler than it actually is. For example, it will be very difficult for the

carrier companies to differentiate between taxable and non-taxable data or how precisely

to measure the data. The bit tax would have to be applied only to the value-added portions

of interactive digital transactions to ensure that there is no double taxation. These issues, if

unresolved, will result in unintended distortions in the calculation of taxes and lead to an

unstable tax system. Another major issue will arise with tax neutrality because

transactions, which are made online, are now taxed differently to normal transactions.

Also the system will not work without total international cooperation and countries that

need the tax revenue to build their e-commerce infrastructure may not receive adequate

funds. Another reason why the system might not work is that the technology for

administration does not exist or remains too expensive. The possibility of fraudulent

actions within the carrier companies may also arise, without any international regulatory

agency to oversee them.

The European e-commerce VAT proposal

Due to the fact that Europe uses a VAT-based tax system, as South Africa does, they

cannot simply accept any new e-commerce system because, if the new system is not

aligned with VAT, tax revenue may be lost. The idea that the European e-commerce

proposal is promoting is that, after any electronic transaction between a seller and buyer,

banks should withhold the required taxes from the transaction and pass the proceeds to the

appropriate governments. A provision is made in the proposal for banks to charge service

fees for withholding taxes. The one problem at present with such a system is tax neutrality

between the sale of goods and services. In order to address that the European Union has

decided to define “virtual” goods in the same way as services. This distinction is

important because the European Union VAT legislation taxes goods and services

differently. Services sold within the European Union are subjected to tax, whereas a

service bought inside the Union for consumption outside the Union is not taxable within

the European Union. This means that if a virtual good is purchased within the European

Union for consumption within the Union the good may be taxed within the Union. If it is

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bought with the intention to consume it outside the European Union it is not taxable within

the Union (Chan, year unknown).

The advantage of this system is that it can be adapted to the already existing VAT

consumption-type tax. Another advantage is that it is expected to have minimal disruption

for most of the world’s current tax regimes. Finally, there will be few new procedural

inconveniences for e-commerce businesses and their clients, as the banks and service

providers collect and distribute the taxes to the governments.

Banks will play a vital role in this tax proposal. Banks would collect and distribute all the

e-commerce tax revenues to the appropriate governments and would perform a

governmental administrative function. Banks could be motivated to increase e-commerce

transactions in order to achieve a higher profit, but an inherent conflict of interest will

incur if banks also have the responsibility of allocating tax funds. The biggest threats are

fraud and abuse in handling the funds and incorrect distribution of tax revenues. An

administrative problem could arise because there are hundreds of tax rate schedules and

protocols with which the banks will have to comply. Also, the longer a bank can keep tax

revenues the greater will be its cash flow and different banks may have different

turnaround times in disbursing tax funds. This means that a government’s timing

expectations might not be met. This will be a problem especially for those countries that

rely acutely upon the funds to ensure the working of their infrastructure. It is important to

have specific and strict monitoring policies as well as audit procedures, which are essential

for maintaining the integrity of the system (Chan, year unknown). An international

regulatory agency would be needed to oversee and organize bank activities and resolve

problems. Jurisdictional issues may arise from that, and each country would need to

contribute to its cost. Certain information needs to be collected for each transaction. If

the customer has to pay the cost of collecting this information gathering as part of the

price, he or she would have to pay more, compared with a normal transaction. This might

hinder e-commerce. On the other hand if the businesses take on the extra cost they may no

longer be interested in offering the goods online. The main question that arises is whether

governments have incentives to expend the necessary resources to oversee and enforce

provider compliance under the plan.

 

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The Clinton administration’s e-card proposal

The e-card system proposed by the Clinton administration is a variant of the traditional

VAT method of taxation. Customers would purchase digital cash cards or e-cards from

banks and they will therefore determine the country of the buyer. Once the place is

established where the e-card has been purchased, this would be the place of consumption.

VAT can easily be calculated and collected together with the sale of the card. The tax

revenue owing to the relevant government will be distributed by a third-party escrow

agent. Estimates indicate that the distribution could be done weekly instead of the two-

monthly distribution governments receive at present and this will help them to establish

their infrastructure more quickly.

This proposal has certain advantages. E-commerce transactions can be dealt with by the

same legislation and tax regulations as normal transactions. One of the biggest advantages

is that Europe and countries like South Africa can keep their VAT-based taxation and

countries like the United States or Australia can tax e-commerce transactions using current

sales tax legislation. Compared with the European proposal, another advantage is the use

of an escrow agency, which will result in greater consistency and reliability due to the fact

that the distribution of tax revenues is centralised. Instead of private banks dealing

individually with the tax revenues, there is only one agent who can act in that matter. The

agency will have a better understanding of the problems and how to solve them. Also, the

agency will not be driven by the same profit motives as the banks, which should result in

higher integrity. In the case of a dispute, question or problem arising governments will

only have to deal with centralised body instead of numerous banks. Another advantage is

that countries like South Africa would benefit because all purchases made in South Africa

by South African residents as well as residents from other countries will be taxed in South

Africa. Developing countries have a chance of receiving higher tax revenues. This

proposal also helps to preserve the privacy of consumers, which may have been a problem

with the other proposals. The e-card will work like cash, which means the only identifier is

the country where the e-card was purchased. It should also be safer to use and accept than

cheques or credit cards (Chan, year unknown).

Problems that may arise with this proposal are firstly that the seller of the cards will play a

big role in collecting and distributing the tax funds to the escrow agency. The seller could

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simply keep some of the money received as taxes and never forward it to the agency. As

the agency has to administer the whole world’s transactions, the system may be complex

and it would be easy to miss a transaction. Would countries be willing to pay for

advanced security measures? Developing countries might not have the money and other

countries might not want to invest in a security system that does not only benefit their own

economy. It appears that the seller of the cards will have to institute a security system,

which will lead to more expenses to be recovered by charging higher prices to customers

for their products. This initial increase in prices may slow down the growth of e-

commerce but, in the long run, prices should fall because once the system is in place no

further costs are involved and other costs, such as storage costs, can be saved. The next

disadvantage relates to the escrow agency. It will be acting as a conduit pipe, funnelling

all the tax collections between the sellers and governments and it plays a key role in this

proposal. It is important to ensure its integrity, stability and credibility. A place needs to

be established for it to be situated and it needs to be monitored. With the world politics as

they are at present, this will be extremely difficult. Why should countries like North

Korea, Russia or China believe that an escrow agency based in America and monitored by

Germany be adequate? The last problem is related to the purchase of the e-cards. What is

the point of this whole system of e-commerce if consumers have to go to town to purchase

their e-cards anyway? However, customers may be more willing to simply purchase a

card at a bank and shop at home (Chan, year unknown). Problems may arise with the e-

cards themselves: are the cards secure enough to ensure they are not subject to fraud and

abuse (Chan, year unknown)? It is submitted that the most serious problem with the

proposal is that the e-card system requires consumers to pay in advance for their

purchases. This may make it less attractive to purchase on-line.

The software proposal

With the software proposal, software would be created that incorporates all the tax rates

used worldwide on any item that could be sold. The retailers would download the free

software and install it on their website and computing platform. The software would be

very easy to install and it would be a technologically neutral system. The software would

be developed with open source code and no one would gain a monopoly or achieve profits

with the software itself, which could compromise its integrity. Using open source code,

programs could be written to help the customer and supplier to calculate the taxes payable.

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For example, a program could be written to help customers keep track of their online taxes

by creating a system that automatically files e-reports under certain categories, helping

customers to differentiate between domestic and business purchases (Atkinson and

Court,1999). Once the program is installed on the seller’s website, it automatically tracks

products sold in order to insure that the right government will receive the correct amount

of taxes. After the customer pays the amount owing for the product, the correctly

calculated tax amount is automatically transferred to the relevant government’s bank

account via electronic payment. This ensures that the right amount of tax is paid, as well

as that the amount will be paid before the seller has a chance to interfere and possibly keep

the money. The program will be coded in such a way that the price per item varies for

each customer depending on which country they are from and what the specific tax rate is.

This information will be collected by the program either from the transaction done via

credit card or e-card or the relevant shipping address (Atkinson and Court,1999).

The problem that arises with this proposal is the same as the other proposals. An

administrative body needs to be created to oversee all the transactions and deal with all the

problems. Where should such a body be situated and how should it be monitored? Some

writers are of the opinion that the World Trade Organization should undertake the

responsibility; others believe that a new body should be created to ensure the integrity of

the system.

A PROPOSAL FOR SOUTH AFRICA

In order to find a suitable proposal for South Africa it is important to consider all the

aspects, ranging from how individuals and companies are taxed at present to prevailing

political views, in order to ensure that a new proposal will work smoothly. As previously

discussed, it is important to maintain tax neutrality and ensure that every country gets the

amount of tax revenue to which it is entitled. Finally, it needs to be ensured that the

chosen proposal can actually work within South Africa’s infrastructure without creating

too many problems.

One of the major sources of tax revenue in South Africa is VAT, which contributes just

less than one-third of the total tax revenue of South Africa (http://www.sars.gov.za; 2007).

With this in mind it seems clear that the proposal to be adopted in South African needs to

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integrate VAT, as it would be too difficult, if not impossible, to change the VAT tax

system to a sales tax system in order to suit a new e-commerce taxation proposal. This

means that the proposal chosen needs to incorporate VAT as well as the sales tax applied

in other countries in order to maintain equity between countries and to guarantee that

every country gets its correct share of tax revenue. South Africa is a developing country

with high costs for the Internet (Olaf Hesselmark: 2003). This might slow down the

growth of e-commerce in South Africa, but does not mean that it is not necessary to find a

suitable proposal because Internet rates will decrease and more businesses will see the

advantages in e-commerce. It would be an advantage to have proper e-commerce tax

legislation set up by the time e-commerce begins to boom in South Africa, to ensure that

the government receives the correct tax revenue at the correct time.

A proposal to be used should be a mixture of the last three proposals discussed above.

The “Bit Proposal” is believed to be the least effective and most expensive proposal and

does not have regard to VAT and will not preserve tax neutrality. The solution for South

Africa is to take the best elements of the other three proposals in order to try and eliminate

as many disadvantages as possible.

In the short term, the “European E-Commerce VAT Proposal” and the “Clinton

Administration’s E-Card Proposal” could be used in conjunction. The first proposal deals

with all the required changes in definitions for a VAT-based tax system in order to

maintain tax neutrality and warrant well-defined tax legislation in countries that use a

VAT-based taxation system. The latter proposal deals with the actual transaction of the

product or service and the supervision of the right amount of tax payable to the right

governments. The important aspect of this proposal is the supervision of any e-commerce

transaction by a taxation agency, which should report to an international economic

organisation such as the OECD or the World Trade Organization to ensure its integrity.

From a South African perspective, it would be acceptable to use such an organization but

to circumvent political issues between countries, a representative of each country should

be represented at the elected organization, to discuss new emerging issues and help with

queries arising around the world. The major tasks the organization will have are not just

to ensure the payment of outstanding tax revenues from the agency to each country but

also the supervision and auditing of the agency. This ensures that the taxation agency

does not take advantage of its position and that every country is treated fairly and is paid

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in a timely fashion. It is important that the agency should be financially sound and solvent

in order to be able to pay everyone the right amount of tax at the right time. If this is not

the case the whole proposal will fail because governments will lose their trust in the

agency and try to get their tax revenues in other ways from the e-commerce transactions.

An organisation should be created that every country can trust, that is solely responsible

for receiving and distributing the funds (Chan, year unknown).

For this proposal to work in South Africa the government has to pass legislation to ensure

that every resident seller withholds the right amount of tax and pays the taxation agency in

time. Rules should also be set out to insure domestic compliance issues are dealt with in

the appropriate professional manner. The proposal would address VAT problems in

South Africa effectively, but certain amendments will have to be made to the VAT Act,

for example:

□ the definition of a “financial service”, which is exempt from VAT, includes the

provision of credit (section 2(f)): the sale of an e-commerce card appears to fit this

description and the definition will have to be amended;

□ the time-of-supply rules will need to clarify that the time of supply is when the e-

card is purchased, not when the goods or services are purchased;

□ to address the problem that certain goods and services are zero-rated (mainly

exports and certain basic consumer goods), while others are exempt (including the

sale of motor cars and entertainment goods and services), the Act will have to be

amended to provide for refunds of VAT pre-paid on exempt or zero-rated supplies

or separate e-cards used for these supplies;

□ the provisions relating to the tax periods used for the payment of VAT would also

need to be amended, as the payment of VAT would occur almost immediately after

the purchase of the credit card;

□ the provisions relating to returns and payments would need to be amended; and

□ the definition of a “representative vendor” would need to include the sellers of the

e-cards as well as the agency that administers the VAT collections and payments.

In the more distant future the “Software Proposal” could be integrated. It may be possible

to start with e-cards being sold online, in which case all that is sold is a code or a personal

identification number (PIN) with which the customer can make all purchases. New

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computer software programs developed by either government agencies or other accredited

developers using open source code, are installed on the supplier’s e-commerce website

and, because the program is coded in open source, any company or programmer can adapt

the programs to create an effective network between the customer, supplier and taxation

agency. The customer will log onto the website and choose the product he or she wants to

purchase. As soon as the product has been selected the software will automatically

calculate the tax amount corresponding with each region using the specific tax rate. The

customer does not have to calculate any taxes, the program will indicate the correct tax

rate in his region or country, calculate the VAT amount payable and add it to the price of

the product. This means that the customer will automatically receive an invoice showing

the net amount of the product, the VAT amount and the gross amount which is the

product’s cost plus the VAT amount. For the customer this system will be very easy to

use and should promote the use of e-commerce.

The supplier installs the program, which is easy and quick to do; the new software will go

hand in hand with e-commerce software such as “Zen Cart”. By checking the taxation

agency’s website the software will automatically update itself to insure the latest

information is available on the supplier’s website. The software is programmed in such a

way that all the taxes withheld, be they VAT or sales tax, are automatically transferred

into the taxation agency’s account with proper reference numbers and dates. This ensures

that all the amounts that are due to a government will be paid correctly and in time. The

system will also keep track of all the articles sold and add up the VAT amounts for the

month in order to help with the preparation of financial statements. Another advantage of

this will be that if a product is returned the supplier can reclaim the VAT with the help of

the software. It will be very easy to track back on products sold due to proper referencing

and dating. The software will also be networked to the supplier’s accounting program

with which the supplier can easily calculate total VAT payable. The output VAT will be

determined by the software from all the electronic sales and input VAT will be determined

by the software from any purchases made online. In future most transactions will be made

online or via networks, which means that the software will do most of the work of

calculating VAT payable. All the documentation at present necessary to file a VAT return

will no longer will be required because the software will take care of this time-consuming

problem. If SARS needs to access any documentation they can easily call it up from the

software used by the supplier.

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The taxation agency will ensure that the software is available free of charge on the Internet

and that it is easily integrated into the supplier’s website. The software will be updated

regularly to ensure that there are no bugs in the system and that the proper tax rates are

being used. The agency will also provide information in relation to problems or give

adequate help to users via forums or service lines. The use of the software should be made

a requirement by the government for any company that is trading worldwide to ensure that

taxes are being paid to the correct governments. The biggest advantage of such software

is that it unifies the revenue collection functions of governments. It treats every country in

the same way, irrespective of whether it is the United States or South Africa, if everyone

uses the program. Everyone will get the correct amount of tax revenue. Payments from

suppliers are easily tracked and can be compared to prior payments in order to predict

future income. It can also help to determine if a company is trying to cheat the system.

The biggest disadvantage is that of potential fraud. If such software is integrated into the

supplier’s system there will always be hackers trying to “crack” the system and embezzle

money. A means will have to be found to keep track of security systems and latest safety

protocols to ensure a safe environment. As much as the software will do most things

automatically a committee that supervises the taxation agencies will still be needed just to

ensure the system’s integrity. The committee will also carry out research to identify new

ways to simplify the system even more and improve it as far as possible.

The way Internet transactions are taxed at present may change slowly to a more computer

based system. Many problems that arise today may be fully automated in just a few years

time. This will allow e-commerce to grow rapidly, due to the fact that it is made so easy

for customers and suppliers alike. The crucial requirement for such a system to work is

that all the governments adhere to the rules and therefore a high level of trust will be

ensured.

HOW THE SYSTEM WILL WORK

To show how the new proposal will work, one company that sells goods online and one

company that renders its services online, namely Amazon.com Inc and Skype

Technologies S.A. Limited, will be used as examples.

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Amazon.com Inc.

Amazon.com Inc (Amazon) is described by Business Week as follows:

Amazon.com, Inc. operates retail Web sites, as well as provides programs that enable third parties

to sell products on its Web sites. The company sources and sells a range of products to its

customers. It offers Amazon Marketplace and Merchants programs, which enable third parties to

sell their products on its Web sites; allow customers to shop for products owned by third parties

using its features and technologies; and enable individuals to complete transactions that include

multiple sellers in a single checkout process. The company, together with third parties, sells various

product categories, such as books, music, DVDs, unbox video downloads… Its retail Web sites

include amazon.com, amazon.ca, amazon.de, amazon.fr, amazon.co.jp, amazon.co.uk, joyo.com,

shopbop.com, and endless.com. The company also provides merchant services for third-party

retailers; marketing and promotional services; and Web services comprising Amazon simple storage

service, Amazon elastic compute cloud, Amazon simple queue service, Amazon mechanical turk,

and Amazon e-commerce service for developers. In addition, it operates other Web sites, including

a9.com and alexa.com that enable search and navigation; and www.imdb.com, a movie database.

The company was founded in 1994 and is headquartered in Seattle, Washington.

(http://investing.businessweek.com/research/stocks/snapshot/snapshot_article.asp?s

ymbol=AMZN; 2007)

After the introduction of both the e-card and software proposals, from the company’s point

of view, nothing will change in the way it advertises or charges prices - the product’s

market price, less the sales tax. The company will not need to change anything until the

full new proposal has to be integrated. The new software will be installed on the website

and properly maintained, which will be required by legislation. The major change does

not lie within the company but rather with the government. It is much easier for the

company to charge the required taxes and pay them over to the taxation agency as the

amounts are transferred automatically. Any problems encountered can be solved by

referring to the agency. The company faces a risk from competitors such as EBay. In

Business Week online, (www.businessweek.com/1999/99_22/b3631001.htm; 2007) it was

held that with the new e-commerce strategies one of the two companies will become the

new leading online store in the future. This will depend upon which business will be more

flexible in its product range and pricing as well as availability to customers all over the

world and its customer service. Because it is more cost efficient and therefore more

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profitable to have an e-commerce store, Amazon should increase their sales. The new e-

commerce tax system will enable a company to reduce its compliance costs and gain a

competitive advantage.

If the proposal should be adopted in South Africa, the customer would purchase an e-card

from a bank, with a certain credit amount. When purchasing the book online from

Amazon, the price of the book will automatically be deducted from the e-card. Due to the

fact that the e-card was purchased outside America, Amazon’s system would recognise

that no sales tax is to be included in the total price of the book. The exchange rate used

will be the spot rate at the time of the purchase. From the customer’s point of view, it is

similar to a normal credit card transaction. Once the software proposal is incorporated,

nothing else changes, except the price at which the book is offered online. The software

automatically recognises the place of residence of the customer. The program will check

online which tax-based system the government is using, either sales tax or a VAT-based

approach, and it checks the applicable customs duties due. The program automatically

calculates the full cost of getting the product from door-to-door. Instead of the customer

having to pay the customs costs when the book is collected from the post office, all the

costs are paid up front. Not only can the book now be delivered to the door, but also the

South African government will receive its share in the tax and customs duty (where

applicable) on the international transaction much earlier, as the taxable amount due will be

transferred immediately to the tax agency’s account. Here, the amount is checked to

ensure that it is correct and compared to latest tax rates and legislation to determine the

amount actually due to South Africa. Once this is done the outstanding amount could be

transferred to the rightful government on a weekly if not a daily basis.

Skype Technologies S.A. Limited

Skype Technologies S.A. Limited (Skype) is described by Business Week as:

... a telephone company, (that) offers Internet communication solutions. The company encrypts

calls, chats, and file transfers before sending it through the Internet. It makes and receives calls to

and from landline and mobile phones, as well as voicemail and call forwarding. The company was

founded in 2003 and is based in Luxembourg … As of October 14, 2005, Skype Technologies S.A.

is a subsidiary of eBay, Inc.

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(http://investing.businessweek.com/research/stocks/private/snapshot.asp?privcapId

=3351436) 

Skype’s service is an online service. Skype offers many services, the main ones are:

Skype-to-Skype, SkypeOut, SkypeIn, SkypeVoicemail. The services are fairly self-

explanatory. Skype-to-Skype is free global Internet telephone from one “skyper” to

another. SkypeOut is the name of the service that allows a member to call a traditional

telephone number from a Skypephone. The global going rate currently is around fifteen

cents per minute. SkypeIn, on the other hand is a service that allows a member to pick his

or her own international telephone number where people can reach them if they don't use

Skype. It allows anyone to call the member on Skypephone without the member having to

have a Telkom number. The last service offered, SkypeVoicmail, is a voicemail offered

by Skype to save messages (www.skype.com; 2007).

 

All of these services offered will cost a certain fee to use. In order for a client of Skype to get credit that

allows the purchase of the service, he will first have to purchase Skype credit. This credit can easily be

purchased via credit card, PayPal or vouchers. Vouchers can be purchased from stores such as Wal-Mart,

which is not in South Africa. It is important to note that “if your billing address is within the EU, you will be

charged 15% (Luxembourg) VAT on top of the amount you require when you buy Skype Credit”

(www.skype.com/intl/en/prices/callrates/?currency=EUR; 2007).

 

According to South African legislation, VAT is payable on imported services (section 14

of the VAT Act) and “VAT is only payable on an imported service when the South

African resident is not a VAT vendor or will not be using the service in his (VATable)

enterprise“ (Huxham and Haupt; 2007:610). From this it is clear that, at present, when a

South African resident purchases Skype credit, no VAT is included in the purchase price

because his address is not in Europe. The taxpayer who is not a vendor should, once the

Skype credit is received, declare to SARS that he is using the service in order to ensure

accurate tax payments (vendors would deduct the VAT, so no revenue would be lost).

However, there are insufficient controls on such transactions to ensure that the VAT

owing is actually paid. How will SARS be able to follow up on such small, undeclared

amounts? One might argue that the amount is insignificant but in 2007 5.1 million users

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are online in South Africa. This is an increase of 112.5 percent in the last seven years. If

only one percent of them use Skype, thus fifty-one thousand members, and each member

spends a minimum of R100 per month on the service, SARS would be losing R714 000

each month. This might not appear to be much compared to the other tax revenues but it

should be kept in mind that this is only one Internet service provider, Skype, and that the

numbers will increase from year to year (www.internetworldstats.com/stats1.htm; 2007).

It is also important to note that there are other Internet services that cannot be controlled

adequately with the present method of taxing VAT on Internet services.

If the proposal should be accepted, Skype would not have to charge any member for VAT,

as it is paid when the e-card is purchased. For Skype this will only represent a change in

its administration of VAT. No problems should arise, because the duty to pay tax on the

taxable amount now lies with the seller of the e-cards. Once the whole proposal has been

developed, as well as the coding of the software, it must be integrated into Skype’s

website. The implication is the same as it is with Amazon. Each price will vary depending

on the member’s origin. As discussed, the software will calculate the total amount payable

by the member and ensure that the tax agency and Skype each receive their appropriate

share.

The purchase of an online service is very simple at present for the customer, but very

difficult to control and check by the government. For companies, the VAT amount paid in

order to use the Skype service can be reclaimed as an input tax, if used for business

purposes (section 17 of the VAT Act). More and more companies are using the service

due to cheaper calling rates for normal telephone conversations and free conversations

from Skype to Skype, which is used by more and more clients.

The new e-card proposal will charge VAT on services in the same way that it would on

goods. The change in definition of goods and services is needed to ensure tax neutrality.

E-cards are being purchased, which means it does not matter if this credit is used to

purchase goods or services. The VAT is paid as soon as the e-card credit is purchased.

This helps the government to control every transaction that is entered into in the country to

ensure that it actually attracts VAT and this does not depend on what the purchase actually

is.

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Once the full system operates, the concept of purchasing an online service will be dealt

with in the same way as the purchase of a good; the service supplied by Skype will be

dealt with in the same way as goods supplied by Amazon. This gives more uniformity to

the system and makes it easier to operate. The software will do most of the work, once

installed onto the supplier’s website. For the customer all that the program does is to take

account of the relevant tax rates and add them to the price of the service, including taxes

such as VAT and customs duties.

THE TAX AGENCY

For the proposal to work, it is of utmost importance that an effective tax agency is

incorporated into the system, whose mission is to ensure the payment of correct tax

revenues to the rightful government and on time. If the integrity of the tax agency should

be compromised even slightly, the whole proposal will fail and governments will lose faith

in the system. It is also very important to keep the tax agency solvent to ensure that

payments are made in time to each relevant government. The agency will be monitored by

an organisation such as the OECD, acting mainly as an auditor and supervisor of the

agency. It should be accountable to more than one government to guarantee fairness in the

decision-making.

Most of the work needed to integrate the software proposal lies with the tax agency. The

program is coded by the agency and updated on a regular basis. The agency must also

make sure that every e-commerce supplier that sells globally has installed the software and

uses it correctly. There may be problems with the program because it is installed and

coded on open source, which could lead to hackers trying to change codes. All that can be

done is to create an Internet police division that supervises and checks transactions. The

whole process of deducting money from the supplier and sending it to the relevant

government is automated for quick transfer of tax revenue. The cost of having such a tax

agency needs to be shared by each government in proportion to its use of the facility. The

more a country purchases online goods or services, the more the government is required to

contribute to the agency.

The main problem that could arise is the billing address of a client purchasing goods or

services online using an offshore account. Especially with online services this could be

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problematic because the offshore account could be in a tax haven and therefore not attract

any tax, but the service acquired is actually used in South Africa. It would be too difficult

to actually control each single call via Skype to see if the taxpayer really lives on the

island. The writer of this research is of the opinion that this could be solved by checking

the client’s TCP/IP configuration (Transmission Control Protocol/Internet Protocol),

which is the basic communication language or protocol of the Internet. Every time a client

is online he or she will have a unique TCP/IP number, which can be tracked by skilled

programmers. The software which is provided by the tax agency should be able to track

back to the computer from where the service or product is being purchased to ensure that

the shipping or banking details agree to the TCP/IP address. If this is not the case the

program should either make the tax agency aware of the fact or deny the purchase of the

service.

CONCLUSION

Initially, in introducing the new e-commerce system, there may be a number of issues to

be dealt with by governments and e-commerce suppliers. Ultimately, in the opinion of the

researcher, with such a proposal the tax revenues will increase substantially over time. The

importance of a proper e-commerce regulatory system has been discussed and it has been

demonstrated that it is of the utmost importance to integrate a system that does not only

suit the South African e-commerce and taxation environment, but is suitable worldwide.

Various systems have been compared and the most suitable one has been recommended.

The research indicates that it is necessary to adopt a supervising committee to ensure that

taxes on e-commerce transactions are paid to the right government and to ensure the

integrity of the responsible tax agency that will be collecting the taxes. Once such a

system is developed and the governments and the committee are satisfied that it is

trustworthy, most of the work is done automatically by software.

Certain changes will need to be made to existing legislation to preserve tax neutrality and

integrate e-commerce transactions, but these changes are likely to be relatively minor.

Once the new system is integrated into the websites of suppliers it will provide great

advantages due to the fact that the tax revenues outstanding will be paid on time and that

the purchase of even small-value goods and services are taxed, so that every tax amount

due to the government is actually paid.

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