IT Law Journal

administrator May 16th, 2004

From FrEE to FEE?
by Ailyn L. Cortez

The only matters certain in life are death and taxes, says an old adage.

Taxation in the Philippines

Governments make exactions for revenue in order to support their subsistence and execute their indisputable and genuine objectives. The underlying tone of taxation is governmental necessity, without it government can neither exist nor endure. “Taxes are the lifeblood of the government and their prompt and certain availability are an imperious need.”¹ As noted by Justice Vitug (2000), this phrase has often been used to justify the need for summary remedies in the collection of taxes. To borrow the words of Cooley, as cited by Justice Vitug (2000), the power to tax “reaches to every trade or occupation, to every object of industry, use or enjoyment, to every species of possession; and it imposes a burden which, in case of failure to discharge, may be followed by seizure or confiscation of property. No attribute of sovereignty is more pervading and at no point does the power of the government affect more constantly and intimately all the relations of life than through the exactions made under it. ²

At present, e-commerce transactions within the Philippines are not taxed. Since the total value of such business is still small, however, closing this loophole is not yet a priority for the government… not just yet.

Internet

The term Internet means collectively the myriad of computer and telecommunications facilities including equipment and operating software, which comprise the interconnected world-wide network of networks that employ the Transmission Control Protocol/ Internet Protocol, or any predecessor or successor protocols to such protocol, to communicate information of all kinds by wire or radio.³ Indeed, it is a network of networks.

John Gage, as cited by Lallana (2003), argues that - “The Internet is not a thing, a place, a single technology, or a mode of governance: it is an agreement. In a language of those who build it, it is protocol, a way of behaving. What is startling the world is the dramatic spread of this agreement, sweeping across all arenas - commerce, communications, governance - that rely on the exchange of symbols.”⁴ The nature of Internet communication is decentralized where its use is limited only by imagination without any boundaries in mind; it does not follow a exact, conventional or uniform pathway. As such, the Internet has become the fastest growing medium. In a country comparison of Internet posted by CIA World Factbook, the Philippines ranked 20 with 4.5 million Internet users as of 2003. Hence, revenue authorities see the new golden goose that lays the golden eggs of the new millennium.

Source: CIA World Factbook Unless otherwise noted, information in this page is accurate as of January 1, 2003

Taxation and the Internet

E-commerce means any transactions conducted over the Internet or through Internet access, comprising the sale, lease, license, offer or delivery of property, goods, services, or information, whether or not for consideration, and includes the provision of Internet access.⁵ With the explosion of e-commerce, it is understandable why the government has been grappling to extend its collection arm in the Internet. In 2001, the Department of Finance of the Philippines announced that it would be reviewing the possibility of taxing e-commerce transactions. Indeed, an interesting business. But how it is taxed? By whom and where? A complex matter with complex issues to resolve.

In Internet Transactions, the primary device used for Internet commerce is the World Wide Web Page. The World Wide Web can be simply defined as a multimedia interactive portion of the Internet, which visually resembles a catalogue or brochure and provides a presence for its operators on the Internet. The best comparison may be to an international telephone directory combining both white and yellow pages. The main difference, however, is that once a user finds an entry that interests him, he may then retrieve more detailed information by following electronic links to other related pages. A common transaction on the Internet is the downloading, or retrieval, of software from a computer located in another country. A user begins the process by using a “directory-assistance”-like search tool to find pages that fit his search parameters. Once a suitable entry is selected, the user clicks on it and his computer goes to that page. The user will usually then find a text and graphical environment where for example, software products are described and offered. The final step when the user requests a program, for example a or business application, and it is sent, usually in minutes, right to the user’s computer. If the operators of a given Web site charge for a product or service, a credit card or other electronic payment system may be used.⁶

Clearly, consumers are getting a ride on sales tax from online purchases at no cost. Perhaps, they are reaping the benefits of a of a temporary tax haziness that needs a well-structured system to eradicate ambiguity. Easier said than done.

The difficulties arise because most tax laws and regulations were passed before the beginning of electronic commerce. Such laws and regulations are rooted in concepts of physical location or presence. Determining where the transaction is sited and identifying key taxing points are often important to the administration of taxes. Then again, the intricacies revolving around the Internet poses a difficult issue in identifying the key taxing points of Internet transactions. While tax compliance relies on such geographical restrictions, such may not exist in the cyber world to identify key taxing points. Indubitably, the multi-faceted nature of Internet and e-commerce makes Internet taxation an extremely complex and compound matter. Hopeless to find new sources of income, a taxman should defy the lure of saying: “Tax the Internet now, ask questions later.”

Opposing Views on Internet Taxation

• Positive. The first group views that taxing the Internet is just and reasonable. For them, the idea of exempting Internet transactions from taxes is illogical. No discrimination can be had between an online and brick-and-mortar business. To allow otherwise would be equivalent to granting such business a clear tax subsidy. Moreover, they are convinced that the online retail market will soon account for sizable chunk of national revenue. This is evidenced by the growing trend in Internet and online business activities. Hence, failure to take advantage of this will mean lost revenues for the government.
• Negative. The second group believes that a free market on the Internet will encourage commerce to exploit this innovative means of exchange instead of the traditional system. Internet is too young and fragile a medium for its derived profits to survive the complex web of national and local taxes. Merchants who utilize this mode of transaction are anxious of the complex collection system that might be compulsorily incorporated in their existing process. Moreover, the vulnerability of Internet transaction should not be opened to the elements of taxation as this would discourage people from bringing into play this revolutionary method. As a consequence, it will accelerate the technological advancement and intensification of the Internet. To put it simply, this group considers Internet taxes would significantly jeopardize the growth of e-commerce.

Proposals of Taxing the Net

The primordial consideration in Internet Taxation is the type of tax that would be utilized. Here are some proposals in taxing the net.

Bit Tax. The term bit tax means any tax on electronic commerce expressly imposed on or measured by volume of digital information transmitted electronically or the volume of digital information transmitted electronically or the volume of digital information per unit of time transmitted electronically, but does not include taxes imposed on the provision of telecommunication services.⁷ The proponent of the bit tax is Arthur Condell, a Canadian economist. As quoted by Atty. Jovi Tanada Yam, “whether the digital bit is part of a foreign exchange transaction, a business teleconference, an Internet e-mail or an electronic check clearance, each bit is a physical manifestation of the New Economy at work. Thus, the new wealth of nations is to be found in the trillion of digital bits of information pulsing through global networks.”⁸ It represents a new tax base that is at the heart of the new economy. It is also a new tax base that is growing. It is a tax base that can be easily identified, one where collection is in few hands. In the New Economy, it would be a tax that is difficult to avoid. ⁹

Soete’s Tax proposal. The advocate of this proposal is Luc Soete, an economist who served as chairman of a European Commission advisory panel on information technology issues. His idea is to tax cyberspace bit by bit. He says that “the new tax base for Internet commerce is to be found in these fast moving bits. We need to adjust the taxation forms to make sure they will include these new Internet activities.”¹⁰ The suggested bit tax is a turnover on interactive digital traffic. “Moving from the old highway to the metaphor of a new highway, Soete’s proposal is to tax the digital traffic on the Information Highway. Whether the tax is levied an the traffic carried by a fiber optic cable or on microwave or whether the tax is levied on interactive satellite traffic, the bit tax presents a way of accessing the new wealth being created by the New Economy.” Soete suggested the tax rate to be .000001 US cents per bit, or about one US cent per megabit. Soete contrasted the bit tax to the VAT: “The main consumption and production tax levied in the European countries is the VAT. VAT allows material goods and services to be taxed at their various points of production and value creation - in a way that is quite easy quantifiable.” in cyberspace, Soete’s bit tax would replace the VAT on immaterial goods and services. The idea is to levy taxes only as “a proportion of the intensity of the information transmission.” The term “transmission” means the number of bits flowing across the wires, not their “transaction value.”¹¹

Loopholes in these proposals. Soete’s bit tax has been attacked on many aspects. At what rate should nations tax digital bits? How would the new taxes be collected? Critics raise a ruckus that a bit tax will prove injurious to the future of the Internet because it would be extremely expensive for consumers to pay the bit tax. At Soete’s rate of one cent per megabit, you can just imagine that cost of downloading a two-hour movie with a transfer rate of two megabytes-per-second. Besides, the cost of the procedure and technical means for collecting such a tax would likely be higher than the revenue, especially as micro-payments for minuscule chunks of information become commonplace. Moreover, some technologies - like satellite communication - simply make it impossible to monitor bitstreams. On the political front, the bit tax was temporarily rejected by the European Union. Soete admitted that “the core goal of the European Union policy is to accelerate the diffusion of information technology in Europe. And any idea that could slow down investments and growth in this areas being rejected - just because it comes at the wrong time.” The European Union has joined the US, Japan and other like-minded countries in keeping the Internet duty-free, until the dust of cyberspace settles.¹²

Internet Taxation in the United States

President William J. Clinton signed the Internet Tax Freedom Act on October 21, 1998. On November 28, 2001, President George Bush signed into law a two year extension to the ITFA. It is an act that imposed a three-year moratorium on new taxes on Internet access fees. The main goal of this act was to prohibit new taxes from being levied on the using the Internet, such as those paid by customers of America Online.¹³

Sales Tax or Use Tax. The term sales tax or use tax that is imposed on or incident to the sale, purchase, storage, consumption, distribution, or other use of tangible personal property or services as may be defined by laws imposing such tax and which is measured by the amount of the sales price or other charge for such property or service.¹⁴

The current moratorium does not exempt an online transaction from a state’s sales tax. The moratorium has never been on sales taxes- that is a misnomer. The moratorium is on new taxes.¹⁵ If a state in its exercise of taxing authority chooses to levy a sales tax, that liability exists without eqard to the medium used to make the purchase (in person, by telephone or mail, or online). If the business does not meet the constitutional test of a substantial physical presence in a states that would require the business to collect and remit the sales tax to that state then consumers in those states that impose sales taxes who make purchases from out-of-state businesses are liable to pay a use tax on those purchases.¹⁶

Nexus Rule. Nexus refers to the physical presence - such as a sales force, distribution center, or a warehouse - a retailer must have in a consumer’s state to be required by that state to collect sales taxes.

The US Supreme Court in Quill Corporation v. North Dakota,¹⁷ pronounced that in order for an out-of-state company to collect sales taxes from another state, physical presence (nexus) requirement must be established. This means that any taxes levied on Internet sales must be the same as those levied on the same sales if they occur in a physical store or through mail order. A state may not, for example, assess one tax rate for merchandise that is purchased in a physical store while levying another tax rate for the same merchandise purchased through the Internet. The Internet Tax Freedom Act proscribes this. To have a nexus, a company must have a store, office, warehouse or a salesperson in That locality.

Purposes of ITFA. The Internet Tax Freedom Act moratorium prevents states from enacting discriminatory taxes on online sales. For instance, under the moratorium, a state is prohibited from charging a new or higher tax on online sales that is not likewise levied on sales achieved offline.¹⁸

As pointed out by Bick (2000) another purpose of the Internet Tax Freedom Act is to prohibit double or multiple taxation of a single transaction. For example, if the buyer of a product must pay taxes on the purchase and the seller of the same product must pay taxes on the sale to that particular buyer, this is a multiple tax and is prohibited by the Internet Tax Freedom Act. Another example would be if an e-vendor is located in a state that sources such income to the state and taxes it where the incomeproducing activity occurred, and sales are made to a jurisdiction that sources such income to the state where the benefit is received and taxes levied, double taxation is possible on the same transaction.¹⁹

To give effect to the purposes of ITFA, the establishment of Advisory Commission on Electronic commerce was convened.

Advisory Commission on Electronic Commerce (ACEC). The Internet Tax Freedom Act established the commission to study the application of taxes to e-commerce and telecommunications. The commission was composed of three federal, eight private, eight state and local government representatives, including Utah Gov. Michael O. Leavitt, Virginia Gov. James Gilmore, and Washington Gov. Gary Locke. The commission sent a report to Congress on April 12, 2000, but failed to reach the required supermajority (two-thirds) to make findings and make recommendations. The commission refused to accept a “minority” report from Gov. Leavitt on behalf of state and local government representatives.²⁰ The goal of the commission was to study the issues surrounding Internet taxation and report back with a formal recommendation.

At the heart of the controversy are sales taxes. Currently, states can’t force an out-of-state business to collect them unless that business has a physical presence in state. The result is that when a purchase is made across state lines, sales taxes often aren’t paid. Few states have made any real effort to collect those “lost” taxes directly. Instead, state and local officials want Congress to let them draft out-of-state firms as tax collectors. However, the commission was not able to secure the two-thirds vote needed to deliver a formal recommendation.

Think Globally, Act Locally

Everyone makes an effort to understand these complex issues. As correctly pointed out by Atty. Jovi Yam, “the best way all of us can help the Net grow is to work collaboratively on what the Net really needs: an uncomplicated infrastructure for fused, convoluted, cross-border Internet Commerce. The tax issue is just one of many complicated questions.” And until a simple principle can be propounded, that Internet businesses would be taxed no more and no less that they are in the physical world, if not, a moratorium on taxes should be declared.²¹ In achieving this, global standards to prop up the Net should be established.

Uniform Business Locator. One of the major problems facing tax authorities in the context of electronic commerce is that of the identify of the parties involved in commercial transactions. In consumer sales over the Internet, the parties may not be known to each other, lest it be via the company handling credit card transactions. In the use of digital money, the ability to trace transactions and identify those involved may be even more difficult. Knowing who you are dealing with is a right if not a necessity of the buyer. It is also necessary for fiscal accountability. To resolve this issue, Alan McCluskey (1998) proposed the Uniform Business Locator. This method uniquely identifies a business or trader and attributes that entity to a specific country. There would be some difficulties with attributing a company to a given jurisdiction. It remains to be seen if the definition of the domicile of a company is satisfactorily covered by current tax legislation and how one would deal with multiple domiciles. One might well need a system that catered for multiple mappings of a company to varying jurisdictions. UBLs would not need to be memorized as they are used essentially as handles to call up more detailed and readily understandable information from the database. As a result they could be randomly generated, unique alphanumeric strings except for the part designed to identify the country. The latter might easily be done using the current two letter ISO country codes. Subsidiaries or branches within a company could possibly be treated like subdomains of the UBL of the parent company.

For a moderate fee, registration with an online commercial registry could be done via the web. Companies or traders would be required to provide the necessary information such as the owner’s name, his or her physical address, tax domicile, telephone number, fax number, e-mail address, web url and domain name. A UBL would then be attributed and would be required in all business transactions including credit card payments and bank transfers as well as for all dealings with tax authorities All UBL’s would be contained in a planet-wide distributed database a bit like for the domain name system. Clicking on a UBL on a web page would call up a small window containing the entry for that company. The outstanding question with such a system would be that of the authentication of the company or trader concerned and the verification that the UBL provided by a web page or the trader’s electronic caddy was really that of the trader in question. A part guarantee in the latter case could be provided by binding payments to the UBL - putting somebody else’s UBL would lead to the money going to that other company.²²

Streamlined Sales Tax Project. This project is an effort by states, with input from local governments and the private sector, to design, test, and implement radically simplified sales and use tax system for the 21st century. Spearheaded by the National Governors Association, the Streamlined Sales Project would require participating states to have only one tax rate for personal property or services effective by the end of 2005. Included in those services would be online sales.²³ The goal of the Project is to substantially reduce or eliminate the costs and burdens of sales tax compliance for businesses through a combination of simplified laws and administrative policies and the implementation of a no-cost system for retailers.²⁴

Under the SSTP model legislation, states will develop uniform product codes and sourcing rules, uniform definition of what is taxable, and simplify administration policies that are consistent with other participating states in the compact. This NGA-led project is seeking to standardize sales tax laws, making them e-commerce friendly. In November 12, 2002, a draft for the proposed subject was finalized and named Streamlined Sales and Use Tax Agreement.

As such the US Supreme Court specifically left it to the Congress to “decide whether, when, and to what extent the States may burden interstate mail order concerns with a duty to collect.²⁵ Congress has the power to modify the existing physical presence standard on which businesses have relied since 1967 (National Belles Hess Inc. v. Department of Revenue Illinois 386 U.S. 753 (1967)) and provide the states with the authority to impose new collection responsibilities on out of state vendors. Neither the Constitution nor the Court imposes any limitation on Congress’ power to regulate interstate commerce in this regard, and the business community urges the Congress to require meaningful simplification of the states’ sales and use tax regime before undercutting the important bright-line standards on which businesses historically have relied.²⁶

Philippine Set-up. The Nexus rule exists because our own Supreme Court has said that the government has no authority to collect taxes from out of town merchants. Technically, the consumer is supposed to pay usage tax on any purchase in which the merchant has not collected sales tax. When you purchase items in a bricks-and mortar store, you can pay any and all local and sales tax that apply to your purchase as part of the transaction. The business acts as a tax collector for the local governments”.²⁷ If you purchase something through the mail, you pay taxes on the transaction only if you live in the same location as the retailer’s business establishment. However, if you do not live in the same location as the retailer, you do not pay taxes to that retailer for your state.²⁸ Following an online purchase, consumers are supposed to go to the Bureau of Internal Revenue Web site to fill out a form documenting their purchase, where they are charged a fee.²⁹ As for now, the government cannot demand out-of-town merchants collect sales tax unless a company has a nexus, or physical presence within that locality.

Conclusion

In the Philippines, the basic question is to tax or not to tax On-line Transactions. Surely, the BIR is seeing a potential gold mine. However we should not discount the fact that E-commerce in the country is relatively young. It seems best that our government takes a back seat for a while and carefully scrutinizes the possibility of exploring the new heights of Internet Taxation.

The Department of Finance should make a thorough study and investigation in dealing the complicated nature of Internet Taxation. Haste makes waste. If the Internet is seen as a tax panacea, the lack of legal framework to address the issues of Internet’s technological leaps and bounds is a significant barrier to the advocates of taxing the Net. Why kill the goose that lays the golden eggs? A Well-developed tax policy in traversing the Information SuperHighway will definitely preserve the goose that lays the golden eggs without sacrificing the fundamental principles of sound tax system: Fiscal Adequacy, Administrative Feasibility and most importantly Theoretical Justice.

Taxing the net should be fair to the average taxpayer. The notion of neutrality on online transaction should prevail because On-line commerce is not radically different from any other form of commerce, but also and above all, on the basis of their declared intention the tax authorities should not bias market choices by their action. The following are the basic issues to be resolved by the Department of Finance in achieving a polished and well-developed scheme of taxing the net.

1. Auditing System. Business establishments issue receipts in every transaction. Pursuant to this receipts, the BIR can keep track of the operations of the business. With the advent of Internet Transactions, BIR should come up with the scheme of an efficient method of determining On-line transactions in lieu of the receipts issued in ordinary mortar and brick business.
2. Tax planning for E-business. Since most of our tax laws were enacted prior the advent of the Internet, a collaboration of the DOF, IT experts and businesses taking advantage of the NET will be an edge in devising a structure with the corresponding tax implications of the Internet Transactions.
3. Efficient Tax Strategy. In taxing On-line transactions, the issue boils down into the efficiency of tax administration. It would be sheer idiocy to propose taxing measures in Internet transactions while BIR has been missing out in collecting the proper amount of revenue from other taxpayers. If the problem is the system, all tax measures are bound to fail.

“There are no obvious solutions at this point, but there are many questions as to how to make future tax laws work. Many are concerned about the expense of developing a tool that would allow online merchants to convert the sales tax on purchase depending on the customer’s whereabouts. Also, there are worries about the use of encryption technologies that could allow people and steer around a Net Sales tax. For now, e-commerce continues to grow and thrive in a sheltered marketplace.³⁰ At the end of the day, nothing is more satisfying that to have days of free Internet.

1. Commisioner v Pineda, 21 SCRA 105 [↩]
2. Vitug and Acosta (2000). Tax Law and Jurisprudence. Second Edition, pg 3. Quezon City, Philippines, Rex Bookstore. [↩]
3. No.6, Section 1104, The Internet Tax Freedom Act. Accessed May 17, 2004. http://www,gseis.ucla.edu/iclp/itfa.htm [↩]
4. Lallana, E. (2003) www eprimers.org/Infoage/page44.asp [↩]
5. No.3, Section 1104, The Internet Tax Freedom Act. Accessed May 17, 2004. http://www.gseis.ucla.edu/iclp/itfa.htm [↩]
6. Muscovitch, Zac (-). Accessed July 16, 2004. http://www.firstmonday.dk/Issues/issue2_10/muscovitch/index.html#Conclusion [↩]
7. No.1, Section 1104, The Internet Tax Freedom Act. Accessed May 17, 2004. http://www,gseis.ucla.edu/iclp/itfa.htm [↩]
8. Yam, Jovi (2001). Net taxation: The Bit Tax. http://www.itmatters.com.ph/column/yam_07052001.html [↩]
9. Cordell, Arthur(1996). New Taxes for a New Economy. Accessed July 14, 2004. http://www.usask.ca/library/gic/v2n4/cordell/cordell.html [↩]
10. Yam, Jovi (2001). Net taxation: The Bit Tax. Accessed. http://www.itmatters.com.ph/column/yam_07052001.html [↩]
11. Ibid. [↩]
12. Ibid. [↩]
13. Glover, Marilee (year). Taxation and the Internet. http://web.utk.edu/~mglover/IS567Paper.html [↩]
14. No. 17, Section 1104, The Internet Tax Act. Accessed May 17, 2004. http://www,gseis.ucla.edu/iclp/itfa.htm [↩]
15. Andal, Dean ( ). “Electronic Commerce: “Bright Line” Definition of Nexus Needed.” Cal-Tax Digest. Sept. 1999. Accessed May 28, 2004. http://www.caltax.org/MEMBER/digest/sep99/sep99-4.htm. [↩]
16. ______. Internet Taxation: Myth versus Fact.” http://www.salestaxsimplification.org/documents/myth.doc. Accessed 1 July 2004. [↩]
17. 504 US 298 [↩]
18. ______. Internet Taxation: Myth versus Fact.” http://www.salestaxsimplification.org/documents/myth.doc. Accessed 1 July 2004. [↩]
19. Glover, Marilee (year). Taxation and the Internet. http://web.utk.edu/~mglover/IS567Paper.html [↩]
20. National Governors association accessed May 19, 2004. http://www.nga.org/legislativeUpdate/HHS/1,2243„00.html [↩]
21. Yam, Jovi (2001). Net Taxation: Duty-free cyberspace… for now. Accessed June 12, 2004. http://www.itmatters.com.ph/ column/yam_06282001.html. [↩]
22. McCluskey, Alan (1998). Taxation and the Internet. Accessed. www.connected.org/govern/taxation.html [↩]
23. Mark, Roy (2002). End of the Beginning: Internet Sales Tax. Accessed July 01, 2004. http://www.internetnews.com/ec-news/article.php/1499501 [↩]
24. National Governors association accessed May 19, 2004. http://www.nga.org/legislativeUpdate/HHS/1,2243„00.html [↩]
25. Quill v North Dakota 504 US 298 (1992) [↩]
26. ______. Internet Taxation: Myth versus Fact.” http://www.salestaxsimplification.org/documents/myth.doc. Accessed 1 July 2004. [↩]
27. Glover, Marilee (year). Taxation and the Internet. http://web.utk.edu/~mglover/IS567Paper.html [↩]
28. Ibid. [↩]
29. Mangalindan, Marciano (2000). The Web Tax is Free… or is it? Accessed 1 July 2004. http://trim811.addsites.com/webtax.html [↩]
30. Mangalindan, Marciano (2000). The Web Tax is Free… or is it? Accessed 1 July 2004. http://trim811.addsites.com/webtax.html [↩]

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