E-Commerce and Tax TreatiesElectronic Commerce and OECD Reports, Part 2

Michael J. McIntyreProfessor of Law

Wayne State UniversityDetroit MI 48202 USA

www.law.wayne.edu/mcintyre

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PE IssuesPresence for E-Commerce as PE

PCan computer hardware, such as a server,constitute a PE?

PCan a Web site constitute a PE?

PCan an Internet Service Provider (ISP) constitutea PE?

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Web Site as PEIs a Web site in a Country a Fixed Place of Business?

PKey is whether the Web site that appears on theuser's computer is the provider’s “place ofbusiness”.

POECD Commentary long stated that “the term‘place of business’ covers any premises, facilitiesor instillations used for carrying on the businessof the enterprise....”

(C) 2001 Slide 14 of 37

OECD Defines Premises NarrowlyHardware Can be PE but Software Cannot

PNew OECD Commentary says that Web sitecannot constitute a “facility”.

P “. . . an Internet web site, which is acombination of software and electronic data,does not in itself constitute tangible property. Ittherefore does not have a location that canconstitute a ‘place of business’.

PSpain and Portugal do not consider that physicalpresence is needed in context of e-commerce.

(C) 2001 Slide 15 of 37

New Business Facility RulesOECD Introduces Two New Obstacles to Taxation

PClaims, without support in language of Model,that business enterprise must have a “physicalpresence” to have a PE.

PClaims that Web site is not “physical” because itis a combination of software and electronic data.< In fact, a Web site requires a physical presence to

exist – it is not “intangible” like stock or copyright.

PTo diffuse opposition, OECD promises toreconsider Model’s definition of PE.

(C) 2001 Slide 16 of 37

Quotation: Web Site Not a PEOECD Commentary to Art. 5 para 42.2

For instance, an Internet web site, which is acombination of software and electronic data, doesnot in itself constitute tangible property. Ittherefore does not have a location that canconstitute a “place of business” as there is no“facility such as premises or, in certain instances,machinery or equipment” (see paragraph 2 above)as far as the software and data constituting thatweb site is concerned.

(C) 2001 Slide 17 of 37

Characterizing E-Commerce IncomeIs Income Business Profits, Royalty, or /Technical Fee?

P If income is business income, it is only taxable ifthere is a PE (and PE hard to get under new OECDCommentary).

P If income is royalty (payment with respect tocopyright), then taxable under Article 12.< Under OECD Model, royalty rate is zero.< Under UN Model, rate subject to negotiations —

usually a substantial rate (10% to 30%)

PSome treaties allow for source taxation oftechnical fees whether or not a royalty.(C) 2001 Slide 22 of 37

Categories of E-CommerceFrom OECD TAG Report 1 Feb. 2001

POECD Established 28 Categories of Transactionsinvolving e-commerce.

PFor each category, it suggested whether incomegenerated by it would be business profits,royalty, or “technical fees” taxable as royalty.

PMost income characterized as business income.

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Application HostingPerpetual License to Use Software: TAG #7

PDefinition. “The user enters into a contract . . .whereby the host entity loads the software copyon servers owned and operated by the host. Thehost provides technical support to protectagainst failures of the system. . . .” Example –“financial management, inventory control,human resource management or other enterpriseresource management software applications.”

POECD Analysis. Business Income. And NotTechnical Fee.

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Application Service Provider ("ASP")ASP Provides Use of Software and Support: TAG #9

PDefinition. The ASP makes a software applicationhosted on its computer servers available to itscustomers. The software automates a particularback-office business function for the customer– automate sourcing, ordering, payment, anddelivery of goods or services used in thecustomer's business, such as office supplies.

POECD Analysis. Part business income and parttechnical fee for support (if special treaty rulefor technical fees).

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Software maintenanceContract for Updates and Technical Support: TAG #12

PDefinition. “Software maintenance contractstypically bundle software updates together withtechnical support. A single annual fee is chargedfor both updates and technical support. In mostcases, the principal object of the contract is thesoftware updates.”

POECD Analysis. Mixed income. Business incomefor updates but perhaps technical fee forsupport.

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On-Line Customer SupportCustomer support over a computer network: TAG #14

PDefinition. The provider provides the customerwith online technical support, includinginstallation advice and trouble-shootinginformation. This support can take the form ofonline technical documentation, a trouble-shooting database, and communications (e.g. bye-mail) with human technicians.

POECD Analysis. Business income.

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Data RetrievalAccess to On-Line Data Base: TAG #15

PDefinition. “The provider makes a repository ofinformation available for customers to searchand retrieve. The principal value to customers isthe ability to search and extract a specific itemof data from amongst a vast collection of widelyavailable data.”

POECD Analysis. Business income, either serviceincome or “sales” of information.

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Technical InformationProvision of Proprietary Information: TAG #19

PDefinition. “The customer is provided withundivulged technical information concerning aproduct or process (e.g. narrative descriptionand diagrams of a secret manufacturing process).

POECD Analysis. “The Group agrees that paymentsarising from this category of transactionsconstitute royalties as they are made for thesupply of know-how, i.e. ‘for informationconcerning industrial, commercial or scientificexperience.’”

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Other TAG CategoriesAll Produce Business Income

P#20: Information delivery

P#21: Access of users to an interactive web site

P#22: Online shopping portals

P#23: Online auctions

P#24: Sales referral programs

P#26: Streamed (real time) web basedbroadcasting

P#27: Carriage fees – fee to have contentdisplayed(C) 2001 Slide 35 of 37

Revision of PE RuleOECD Study of PE Rule

The Committee wishes to stress that the changes includedin this document deal exclusively with the permanentestablishment definition as it currently appears in Article5 of the OECD Model Tax Convention. The TechnicalAdvisory Group (TAG) on Monitoring the Application ofExisting Treaty Norms for the Taxation of Business Profitsin the Context of Electronic Commerce has been given thegeneral mandate “to examine how the current treaty rulesfor the taxation of business profits apply in the contextof electronic commerce and examine proposals foralternative rules.”

(C) 2001 Slide 36 of 37

Possible PE RevisionsSuggestions for OECD or UN Model

P Article 5(5) may be amended by the removal of therequirement that the agent be a “person.” Enterprisesthat carry on a business in a country through a“thing,” whether tangible or not, that satisfy the otherrequirements of article 5(5) set out above will have aPE and be taxed on the profits attributable to that“thing.” See “Clicks vs. Bricks: the Interaction Betweenthe OECD PE Concept and Web Sites,” 22 Tax Notes Int'l1821 (Apr. 9, 2001) by Niv Tadmore

P Other Ideas?????

(C) 2001 Slide 37 of 37