E- Commerce and Taxation:
An Update on the Downturn and Aggressive Taxation Policies:
Although there are talks of “green shorts” of the recovery, the downturn continues. We previously discussed in the article “Downturn and Aggressive Taxation”, how US and Indian tax authorities are becoming aggressive about perceived lost tax revenue as a result of the downturn.
As governments search for increasing revenues, online and e-commerce sales have been targeted for tax collection worldwide. Online retail sales in US rose to $32.4 billion and accounted for 3.6% of all retail sales in the second quarter of 2009. Pursuant to the Associated Chambers of Commerce and Industries in India (“Assocham”) reports, e-commerce in India grew by 150% to INR 5500 crores in the fiscal year of 2007-2008.
There have been recent aggressive measures to collect online sales related tax in the US. This article will discuss such measures and what the position is in India.
A recent example is the Amazon case (“Amazon.com LLC v. New York State Dept. of Taxation and Finance, N.Y.S. 2d, 2009 WL 69336 (N.Y. Sup. 2009)”), wherein the New York court upheld a new state tax law that required out of state retailers to collect state sales tax on purchases by New York residents. Amazon.com challenged the law on constitutional grounds, but the Manhattan Supreme Court held that Amazon.com did not demonstrate unconstitutionality of the law.
The Manhattan Supreme Court dismissed the suit filed by Amazon.com against the State of NY, alleging violations of the Commerce Clause of the US Constitution and the Due Process and Equal Protection Clauses of the NY and US Constitutions. The Equal Protection Clause, part of the Fourteenth Amendment to the United States Constitution, provides that "no state shall deny to any person within its jurisdiction the equal protection of the laws" and the Commerce Clause prohibits states from enacting laws that benefit in-state businesses and discriminate against out-of-state businesses.
The court held that the new law passed by the State of NY targeting online sales and requiring that online retailers collect and remit sales tax to the state was sufficiently in line with existing laws requiring retailers to have nexus, or a significant relationship, in the state before imposing sales tax.
Background:
In 1992, the US Supreme Court in Quill Corp. v. North Dakota, 504 U.S. 298 (1992) exempted out of state retailers from collecting sales tax in out of state transactions, i.e. where they sold goods to residents of a state where the retailer had no physical presence such as a store, office, or warehouse.
Although Quill was concerned with a mail order company, the ruling has since been relied upon by a growing number of remote online sellers. Therefore, if an online retailer has a physical presence in a particular state, such as a store, business office, or warehouse, it must collect sales tax from customers in that state. If a business does not have a physical presence in a state, it would not be required to collect sales tax for sales into that state.
In April 2008, NY sought to overcome the Quill decision when it approved a new tax as part of its 2008-09 state budgets. New York Tax Law section 1101(b)(8)(vi) contains a “Commission-Agreement” provision requiring out of state online retailers to collect New York state sales tax if the retailer uses independent contractors or other New York residents to solicit sales in excess of $10,000 from New York residents.
As discussed above, the law had an immediate impact on large online retailers such as Seattle-based Amazon.com, which previously did not have to collect sales tax in New York because they did not have a physical presence in the state. However, Amazon.com and many other retailers have affiliate linking programs that enable other websites to maintain a link to the online retailer’s site.
Affiliate Marketing is an Internet-based marketing practice in which a business rewards one or more affiliates for each visitor or customer brought about by the affiliate's marketing efforts. An important detail in the sales tax legislation is that e-retailers with affiliates in these states must collect sales taxes on all purchases made by state residents, not simply on purchases originating on local affiliate web sites because the new laws determine that maintaining affiliate relationships is enough to establish a retailer’s presence in the state.
New York tax officials had contended that Amazon.com’s affiliate program makes it subject to the commission-agreement provision of the new tax law, forcing Amazon.com to collect sales tax on transactions with New York residents. Indeed, state officials referred to the tax as the “Amazon tax.”
Impact of the Amazon Case:
As a result of the Amazon case, Overstock.com, Inc., (a leading online inventory overstock retailer) (“Overstock”) has ceased to have business with its marketing affiliates in four states -- California, Hawaii, North Carolina and Rhode Island in order to avoid collecting sales tax. Lawmakers in these states have passed or are preparing to pass legislation that would require companies (online or otherwise) to collect sales tax if they have marketing affiliates in the state.
However, threats by retailers to cut off affiliate marketing relationships in states that have been trying to tax sales generated by affiliates have had an effect. The governors of California and Hawaii have vetoed legislation that would have imposed such taxes in those states. The governors acted after such major online retailers as Amazon.com Inc., Blue Nile, Inc. and Overstock began cutting off affiliates in states that adopted/or were to adopt laws requiring collection of sales taxes by e-retailers with affiliates in those states. Overstock subsequently resumed its affiliate marketing in California and Hawaii.
Scenario in India
Internet usage has grown dramatically in India, as an example, in 1998 there were 1.4 million internet users in India and in 2009 the number of users soared to 45.3 million according to the Internet and Mobile Association of India (“IAMAI”). India has not been left far behind in the race of Internet penetration. For instance, online tax filing went up by 504% this year. Online sales account for 18% of total financial products sales in India (pursuant to a study by Google and Media Screen).
There two key areas of the internet that may be taxed: e-commerce and online services.
E-commerce essentially means using the internet as a means for buying, selling and transmission of goods and services. Sale of goods is liable to value added tax and provision of service is liable to service tax in normal circumstances. However, there is an issue of jurisdiction and liability in of taxation of e-commerce. Pursuant to Chapter V (Service Tax) of the Finance Act, 1994, Section 65(19), online services of online information and database access and retrieval are liable to service tax. Websites charging for accessing information or data in any form may be liable to service tax. Most of other services provided over the Internet are covered under various heads of service tax.
There is limited jurisprudence on online taxation in India but there has been a recent ruling by the Authority for Advance Ruling (“AAR”) in Cargo Community Network Pte. Ltd. (289 ITR 355) on this subject. In this case a Singapore based company (Cargo Singapore) was providing access to its internet based air cargo portal hosted at a server located in Singapore to various Indian agents by charging one time system connect fees, monthly subscription fees and help desk charges.
The portal enabled Indian cargo agents to access the data bank of various airlines like flight schedules, availability of cargo space, etc. The portal transmitted data fed by agents to the airlines and vice versa by converting them from simple English language to Cargo IMP data. The agents were provided with an exclusive password in order to access the portal. No software program was installed in the computer system of the Indian agents. The subscriptions made by agents and agreements signed for usage of portal was directly with head office in Singapore. Inter alia, on these facts Cargo Singapore sought an advance ruling from the AAR as to whether the payment made by the Indian agents for providing passwords to secure access and use the portal hosted from Singapore was taxable in India.
The AAR in its ruling concluded that the fees paid by the cargo agents were in fact payments towards ‘equipment royalty’ both under the Income tax Act as well as India - Singapore Tax Treaty and therefore Cargo Singapore was liable to pay income tax under the Income Tax Act, 1961.
As the Cargo Singapore case demonstrates, there are difficult questions regarding online sales tax: (i) jurisdiction (where the vendor is located or the one in which the customer is located) has the right to tax; (ii) location (it is difficult for the vendor to find out where exactly the customer is located); and (iii) collection of taxes (the vendor may not have any contacts in the customer's location to collect taxes). Finally it is not clear whether e-commerce transactions are to be treated as goods or as services in the context of domestic taxation.
There are useful rules from international trade where there is no ambiguity if a product is ordered over the internet and if it were to be delivered in the conventional manner. Such transactions will be treated as the sale of goods and GATT (WTO) rules on trade in goods apply.
With respect to domestic trade, ambiguity arises if goods are transmitted electronically across the internet (newspapers, journals, other printed matter — scanned and sent in digital form — CDs, tapes, software, etc.). Arguably, the electronic delivery of goods may be classified as services.
Therefore, taxation of e-commerce transactions in the Indian context is relevant as it applies to sales taxes (levied on goods) and service taxes (levied on services), as well as to direct income from e-commerce.
Internet-based businesses differ from brick and mortar businesses because internet businesses may need just one physical location yet they may deal with buyers throughout the world. As a result, cross border e-commerce transactions pose a challenge to the tax authorities including issues related to double taxation.
The key income-tax issues currently faced in cross border e-commerce transactions involve determination of: the place of accrual of income, the character of income, whether a Permanent Establishment (“PE”) in the source country is constituted and if so, the quantum and manner of attribution of income to the PE.
While there have been judicial developments in the US regarding e-commerce taxation, the taxation of e-commerce in the India is still developing.
Lastly, the Government of India has recently tabled the “Direct Tax Code” with the objective of simplifying and rationalizing tax provisions. Although the code does not directly deal with taxation of online sales and e-commerce, it deserves further study in this context.
Shantanu Surpure, Managing Attorney, Sand Hill Counsel