Building an Effective Etaxplan

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  • 7/27/2019 Building an Effective Etaxplan

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    By Chuck Ormrod, KPMG

    mean that some virtual transactions are subject to reduced

    taxation. This can increase earnings and consequently

    valuations for the company as a whole.

    Developing an e-fragmentation tax strategy is not a simple

    process, and professional e-tax planning advice is essential.

    To be successful, the tax strategist needs a deep understanding

    of where physical operations and customers are located and how

    the business adds value in each location. Also critical are

    knowledge of the local tax issues in all relevant jurisdictions, and

    awareness of new developments in international tax legislation.

    Permanent establishment or not?

    E-businesses must typically operate at warp speed, making

    critical planning and investment decisions on a moments notice.

    Such decisions can have unintended tax consequences for

    example, when a business increases its overall tax liability

    by creating a permanent establishment (PE) in a particularjurisdiction.

    Generally, a permanent establishment is defined as a fixed place

    of business or management, or a permanent representative with

    authority to enter into contracts. International tax treaties use

    the PE concept to define the jurisdictions in which a business

    is taxed.

    However, in the context of e-business activities, the permanent

    establishment concept is constantly evolving and raises

    difficult interpretive questions. For example, the OECD has

    recently determined that a Web site hosting arrangement doesnot result in a PE but the location of a server that is used

    for a core business activity may do so.

    Permanent establishment issues are also important under

    Canadian tax law, because they determine the allocation of

    taxable income of a corporation between Canadian provinces.

    An allocation of the total income of the business is required to

    each taxing jurisdiction which in turn requires a transfer

    pricing policy, standards and analysis.

    Professional tax advice on PE issues can help minimize an

    e-business tax footprint, wherever its operations are located.

    world of opportunity is available to businesses in

    todays cyber economy. However, tax ambiguities

    have created confusion because of uncertainty as to how to

    apply tax laws to e-commerce transactions. A proper strategic

    tax-planning component needs to be built into an e-business

    strategy so that after-tax profits and shareholder value can bemaximized.

    This article examines a few of the fundamental e-tax

    issues that should be considered in the course of developing

    an e-business strategy.

    Keeping key employees tax happy

    Stock-based compensation plans are often used to attract and

    retain key employees. But fierce competition for highly

    talented employees means e-business equity participation

    plans need to be as good as or better than those of competitors.

    To make a real difference, these plans must be tax-effectivefor both the employee and the employer.

    Stock option plans are not always the best alternative, since

    the benefit to the employee is not deductible to the employer,

    and valuation ranges may be so wide that they preclude the

    employee from tax preferences.

    As an alternative, an employee share purchase plan (ESPP)

    should be considered. Under this plan, if an employee holds

    the shares for more than two years, there may be significant

    tax advantages to the employee, and final disposition of the

    share may even be free of tax.

    Location, location, locationUnlike traditional bricks-and-mortar businesses (which are

    usually taxed based on their physical location), an e-business

    is virtual and therefore can be fragmented into separate

    components (e.g., production, distribution, payment

    processing and advertising) that can be based in different

    locations around the world.

    This e-fragmentation approach can create tax advantages.

    Locating parts of an e-business in a lower-tax jurisdiction, such

    as Barbados, Hungary, Ireland, Cyprus or the Netherlands, may

    A

    conti nued on the inside back cover

    Building an effective

    e-tax plan into an e-business strategy

    A World of O ortunities

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    Identifying exposure to sales and local taxesCompanies doing business in Canada must comply with a

    number of different sales tax regimes, including the federal

    Goods and Services Tax (GST), the blended federal/provincial

    Harmonized Tax (HST) and the retail sales tax (RST) levied

    by many of the other provinces. For those enterprises

    conducting business in Quebec, an appreciation of the specific

    requirements of the Quebec Sales Tax (QST) is crucial.

    Even if they are not resident in Canada, companies doing

    business via the Internet must ensure that they are meeting

    their tax obligations in all relevant jurisdictions and ensure

    they are not missing out on any refund opportunities.

    Dealing with shareholder wealth concernsShareholders of Canadian e-businesses, whether public or

    private, face unique tax planning issues where their business

    is expected to increase in value dramatically in the future.

    Consideration must be given to plans that ensure that

    shareholders have flexibility to monetize new-found wealth

    without having to pay too much tax. A carefully structured exit

    strategy, which defers tax on the disposition of shares of an

    e-business, may be the answer to this matter.

    Considering R&D tax incentivesThe Canadian government spends over $1.5 billion annually

    encouraging research and development (R&D) domestically

    and attracting foreign investment. These incentives are

    delivered through the tax system rather than through direct

    government grants.

    Many e-businesses incur expenditures that qualify for

    investment tax credits under the various R&D programs.

    As a consequence, it is extremely important for e-businesses

    to identify the various federal and provincial incentives

    available and to consider them when looking for opportunities

    to capitalize on tax savings.

    For example, depending on its tax status, some e-businesses

    may be eligible for combined tax credits ranging up to 70% of

    R&D wages. A 100% deduction is available for qualified

    Canadian current and capital expenditures.

    Turning losses into tax gains

    While many e-businesses have created huge market wealth

    for shareholders and valuable corporate intangibles, many are

    yielding losses from a tax and accounting perspective.

    Knowing how to turn tax losses into money is a key strategy

    and risk-minimization technique.

    Where loss transfer techniques to sister enterprises are

    unavailable, alternatives should be considered. However,

    strategies such as outright sales of tax losses are complex,

    uncertain and economically inefficient.

    One technique that is gaining popularity is flow-through

    financing where investors, rather than the enterprise itself,

    utilize the tax loss. These structures lower the marginal cost of

    capital for the enterprise.

    Spin-offs and consolidation planning for futuregrowth opportunitiesWhen planning the tax aspects of a start-up e-business activity

    that is internal to an established business, it is essential to

    anticipate the time when shareholders may want to own that

    valuable component or segment of the company separate from

    the company itself. It is also important, however, to plan for

    consolidation. As an industry matures, its likely that larger

    companies will be looking for smaller businesses to acquire.

    Balancing the economic potential of an undiluted pure play

    with the diversified strength of a large conglomerate is a

    difficult judgment. Boards of directors must maintain the

    opportunity to spin out business components to meet their duty

    to maximize shareholder returns. Choosing the proper tax

    structure to enable such an action is a key consideration.

    Plan aheadProfessional e-tax advice and strategic foresight before, not

    after, the development of an e-business strategy will help

    limit tax exposures and uncover hidden opportunities to

    maximize after-tax profits and shareholder value.

    Chuck Ormrod is partner in charge of

    KPMGs e-Tax Solutions practice in Canada.

    continued from the inside front cover

    The O rganization for Economic Cooperation and

    D evelopment (O EC D ) is leading the drive to establish

    international consensus on e-commerce tax issues.

    In the last four years, the O EC D has held several major

    international conferences and published numerous reports

    on the taxation of Internet transactions.

    M ost recently, the O EC D released

    changes to the M odel Tax Convention

    providing greater certainty on how the

    "permanent establishment" (P E)

    concept applies to e-business.

    A report on these im portant new e-tax

    developments is available on KP M G s

    web site at http://www.kpmg.ca/tax.

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    www.kpmg.ca

    The less your professional advisers understand about your business coming in, the more youll have to teach them. And the

    longer it will be before theyll have anything useful to contribute. But KPMG has chosen to focus on key sectors like e-business.