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| The Muddy Muddy Waters of e-Commerce Tax |
July 12, 2005 |
By Jim Middlemiss
When Tristan Goguen started Internet Light and Power in 1995, he was an early entrant into the Wild West of online commerce, providing Internet access to businesses and consumers, mostly in Ontario.
Little did he know he was also entering the Byzantine world of e-commerce taxation, where borders are irrelevant and governments struggle to come to grips with business transactions in an online world. Figuring out what taxes to pay, he said, “is a very thorny problem. We were lucky. We had a good (accounting) firm working with us.” Not so lucky were some of his competitors, he said, who had to close up shop because they were hit with huge tax bills for failing to collect the correct taxes.
Even Goguen had a brush with tax authorities. Within three months of launching his Internet service provider operation in Toronto, Goguen said, “we had the pleasure of being audited (by provincial tax authorities). There were a couple of minor things that they helped us out with, which we appreciated.”
One of the challenges, he said, is that ISPs provide a blend of services, some of which incur provincial tax while others don’t. “So it’s important for service providers and online firms to spend time to make sure they are compliant with the tax regime.”
Internet commerce is still young in Canada, but online sales are growing rapidly. According to the 2003 Survey of Electronic Commerce and Technology, the most recent figures available from Statistics Canada, online sales accounted for less than one per cent of operating revenues at private-sector businesses and about seven per cent of private-sector firms sold goods and services online.
However, year over year, online sales keep climbing.
Combined public and private online sales in Canada hit $19.1 billion in 2003, up 40 per cent from 2002, with the private sector driving the bus at $18.6 billion in sales.
Confusing rules
And the taxman wants his cut. The problem is that the tax regime is a real mishmash when it comes to online transactions. You could find yourself responsible for collecting taxes for locales where you don’t have an office.
“What’s facing sellers is the fact that you have this mixture of different tax regimes across the country,” said Terry Barnett, a partner in the B.C. office of Thorsteinssons, a tax law firm.
“It’s a patchwork,” agreed Brian Pel, a tax lawyer at McCarthy Tétrault LLP. “It’s messy.”
Lawyers say there are basically two types of taxes that online firms have to watch for: commodity taxes and corporate taxes.
Commodity taxes
The basic concept behind a commodity tax is that consumers of goods or services foot the bill when they buy something. In Canada, there are the federal goods and services tax (GST) and provincial sales taxes (PST).
While it’s easier to figure out what taxes to collect if you’re selling or buying goods and services in the province in which you’re situated, it’s less clear when the transaction crosses borders — provincial or international. It becomes even more confusing when the item is intangible, such as software, as opposed to tangible goods, like clothing or books.
That’s because tangible items have to be delivered, so theoretically they can be tracked. However, if a customer downloads a book, song or movie from a Web site, it’s harder to track. So by law, purchasers have a duty to self-assess and report those purchases to their local tax authorities, whether they’re bought from outside the country or outside their own province, but few do.
The GST is relatively straightforward. It’s a federal tax of seven per cent applied to the purchase of most goods and services.
Pretty much every business earning more than $30,000 is required to collect and remit the tax to the federal government.
Where it gets tricky is that there’s a complex set of rules that apply as to what constitutes a good or service and which transactions attract tax, Barnett said.
Complicating commodity tax matters is the fact that the provinces are all over the map when it comes to their sales tax regimes. For example, Alberta doesn’t have provincial sales tax.
Nova Scotia, New Brunswick and Newfoundland have harmonized their PST with the GST and impose a 15 per cent hit on goods and services.
“The problem for some of the retailers is they don’t think that selling to someone in those three provinces means you have an extra eight per cent to worry about. It’s easily overlooked,” Barnett said.
Other provinces have their own stand-alone PST systems, but they are far from similar. Some provinces charge PST on certain services or goods, and others don’t. For example in B.C., legal services are taxable, but they’re not in Ontario. Internet access draws PST everywhere except Ontario and Alberta.
As well, the PST rates differ across provinces and are applied differently. For example, some provinces apply PST on the sales price before GST and others apply PST on the price of the good or service after GST has been included, a subtle difference that can quickly add up.
But here’s the bit to remember: just because your operation is in Ontario and you sell into B.C. or Europe doesn’t mean you’re exempt from charging and remitting local sales taxes. That’s because some jurisdictions reach out beyond their own borders, or at least try to.
“B.C. has a rule that anyone who sells and delivers goods to residents in B.C. and who advertises to residents of B.C. is obliged to register under the B.C. system and collect sales tax.
Other provinces aren’t quite so aggressive and take the position that if they have no presence in the province, the retailer doesn’t have to collect the tax,” Barnett said.
Pel said it’s questionable whether the law would pass constitutional muster, but said: “You don’t want to be the test case.”
But it’s not just selling in Canada where you can fall into a tax snare. The European Union also takes an extra-jurisdictional approach to that region’s Value Added Tax (VAT), which is similar to GST. Foreign firms with $100,000 (Euro) in sales are required by law to register and collect the VAT.
Corporate taxes
While online retailers face challenges with commodity taxes, they can also trip up when it comes to corporate taxes, though Jacques Sasseville, head of the tax treaty unit in the Ottawa office of the Organization for Economic Co-operation and Development, said the focus lies more on commodity taxes.
“In terms of corporate taxes, it’s pretty much business as usual. There were fears back in the late 1990s and early 2000 that the whole of the revenue base would disappear and people would not sell through Wal-Mart (retail locations) but on the Internet...that has simply not happened.”
Adrienne Oliver, a corporate tax partner at Ogilvy Renault LLP in Toronto, said the good news for Internet sellers when it comes to corporate taxes is that “most governments haven’t really taken a very aggressive role in dealing with e-commerce.”
Governments, she said, are content to let the home jurisdiction of the Internet seller go after corporate taxes largely because no Wal-Mart-like giant has emerged online to steal business away from local retailers, thus destroying the corporate tax base. “The government doesn’t seem to think there’s much leakage involved in income tax. That might change once they solve the commodity tax problems.”
However, that doesn’t mean Internet sellers should throw caution to the wind, said Dov Begun, a tax lawyer at Osler Hoskin & Harcourt LLP in Toronto. Begun said the key things for determining whether you are going to owe corporate income taxes in a province, state or country that you sell into is the notion of a permanent business establishment and the type of income you’re earning. “Not all income is taxed in the same way.” Royalty income is treated differently than business income, for example.
Business profits, he said, are taxable in the country associated with the permanent establishment. However, the OECD and its member countries, such as Canada, have taken the position that a Web site alone is not enough to constitute a permanent establishment for tax purposes. However, a server located in a jurisdiction could create a permanent business establishment. So a foreign business that has a server in Canada could be subject to corporate withholding taxes, even though it doesn’t have an office here. “You want to be cautious about where you place your servers,” Begun said.
A similar concept applies on a provincial level, he said. If you live and do business in Ontario, but have your computer servers stored in another province, “there may well be an issue.” The factors tax authorities consider are:
> Do you own the servers or lease them?
> What control do you have over them?
> What type of activity takes place on them?
> Do you share them with other firms?
Goguen made sure his servers were located in Ontario, and takes the position that he is operating in Ontario and the services he sells are bought there. His latest service, ipermitmail.com, an online spam blocker, has more clients from outside the country than inside. Nonetheless, he charges everyone GST and they pay. “We think we’re delivering this service in Ontario,” he said, noting he’d rather be safe than sorry.
“The best practice for a company that doesn’t want to be tainted” is to register with the various provinces in which it sells and collect and remit the appropriate taxes, Pel said. He added that “it’s a real pastiche. You have to get professional advice.”
“I think there are going to be territorial wars as far as taxation is concerned,” Goguen said. He employs one person dedicated to government regulatory activity, including tax. “I expect others have even more. There is a real cost to doing business in multiple jurisdictions.
It’s important to synchronize the various tax regimes and have everyone agree where the tax should be paid.”
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