Solving the e-commerce tax riddle

Retailers should be freed from the burden of collecting tax on web sales
OECD Centre for Tax Policy and Administration

Burst bubble or not, the digital economy continues to grow, as mainstream businesses move transactions online and e-commerce specialists such as Apple’s Music Store, e-Bay and Amazon thrive. That makes governments keen to collect taxes on online sales.

In particular, they are eyeing major growth in the market for downloaded products, now that broadband is being rolled out. With some companies in the segment reporting a trebling of sales in the last 12 months, governments want to head off the development of a tax-free zone for online sales.

Indeed, the European Union’s new rules on value added tax (VAT) for e-commerce came into force on 1 July 2003. The EU created an online system for businesses based outside the Union to pay taxes on web sales to EU citizens. A host of other countries are likely to follow suit with their own rules.

If they do, businesses will suddenly face a hodgepodge of government tax collection mechanisms. The resulting complexity could overburden firms – especially small and medium-sized ones with limited resources – and stifle the development of cross-border e-commerce.

Collecting tax for online sales is a hard nut to crack, especially when it comes to products such as software and music that can be pulled off the web from anywhere in the world. In 2001, OECD countries agreed that consumption taxes for purchases made online should be paid in the customer’s country of residence, no matter where the retailer is based. If, for instance, a teenager in Hamburg downloads a song from Music City’s server in the US for 99 cents, the company should collect Germany’s 16% VAT and send it to the German tax authorities. But businesses in the US, or anywhere else for that matter, are likely to bridle at the prospect of collecting tax for dozens of countries half a world away.

Is there an easier way? Only if countries break out of their traditional practice, which places the burden of collecting taxes on the retailer, rather than the buyer. To move forward, governments and businesses must collaborate to create a new approach that is simple and cost-effective. Governments must commit to reducing the administrative burden on companies, while the business community should explore innovative, technology-based alternatives to the current system.

One alternative, for instance, might be for traditional payment services with well-established global reach, such as credit card companies, to expand into the new business of collecting and distributing VAT receipts. Another might be for the newer online payment specialists such as e-Bay’s PayPal, which handles online auctions, to step in. Of course, privacy and security issues would need to be addressed so as to protect both consumers’ rights and those of tax administrations.

Such big shifts will not happen overnight. At present the volume of global retail trade in digitised products probably does not warrant the sort of investment that would be required to design, build and operate sophisticated new tax collection systems. But the pressure for change is likely to grow quickly as the economic recovery gains momentum and the market for downloaded products accelerates.

A new system might be adapted for other uses, such as collecting customs duties on the millions of dollars in goods shipped internationally. Rather than the customer getting a nasty shock when the postman turns up with a package and demands US$20 for customs duty (plus a US$5 administration fee for the pleasure of paying), payment would be collected when the order is made. That approach already works successfully for retail trade between Canada and the US.

No matter what the final solution, it is high time for some radical thinking on how governments and business can ensure compliance with tax rules, while at the same time making it easier for retailers to reach across borders. The OECD will be working with business people as well as governments over the coming months to kick-start this brainstorming. Finding solutions will help spur the development of new distribution channels for everything from software to videos, which would be music to most people’s ears – including our teenager in Hamburg.

Reference

Holmes, D., “E-commerce tax: A sober view of cyberspace”, in the OECD Observer No 230, January 2002.

©OECD Observer No 239, September 2003




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