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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.
