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Dr. Ikramul Haq, a leading international tax counsel, is a well-known author specialising in international tax, press, intellectual property, corporate and constitutional law. Dr. Ikram is Chief Partner of Lahore Law Associates (fax: +92 42 7226953, e-mail: irm@brain.net.pk; website: http://www.paktax.com.pk). He is a member of the visiting faculty of the Institute of Direct Taxes in Lahore. He served for 12 years as Deputy Commissioner of Income Tax. He studied literature, journalism and law, for his Masters and Doctorate degrees. He has written many books on various aspects of Pakistani law and global narcotics trade, some of which are co-authored with his wife, Mrs. Huzaima Bukhari.


The global electronic commerce[1] (E-commerce) has facilitated the people to transcend the barriers of time and distance. Opening up a New World of economic possibility and progress, it promises a complete transformation of our life in the next decade. In the coming years, E-commerce will allow people to take advantage of global markets and business opportunities in the easiest possible way that is not even imaginable today. The Global Information Infrastructure (GII), developing at an amazing pace, is already transforming our world into a single global community. Internet technology has already shown its profound impact on the global trade in services.

World trade involving computer software, entertainment products (motion pictures, videos, games, sound recording etc.), information services (database, online newspapers), financial services, and professional services (business and technical consultancy, accounting, architecture design, legal advice, travel services etc.) has grown rapidly in the past decade now accounting over $70 billion of U.S. exports alone. “Globally, there are almost 200 million people on the Internet. In the United States alone, 80 million. The numbers tell just part of the story: the Net is no longer a novelty, an interesting way to pass the time. A third of wired Americans now do at least some of their shopping on the Net, and some are already consulting doctors on the Net, listening to radio on the Net, making investments on the Net, getting mortgages on the Net, tracking packages on the Net, getting news on the Net, having phone conversations on the Net, checking out political candidates on the Net, even um, having sex on the net. Each of these activities is impressive, but the aggregate effect is a different kind of life.”[2]

Commerce on the Internet could total tens of billion of dollars by the end of this century. The actual figures of world e-commerce revenue (business to consumer and business to business) from 1996 to 1998 and estimation for 1999 to 2003 below reveal the tremendous future potential.

World e-commerce revenue, business to consumer World e-commerce revenue, business to business
$200__________________________________ $1.25_________________________________
  150_________________________________   1.00_________________________________
  100_________________________________     .75_________________________________
    50_________________________________     .50_________________________________
1996979899*00010203 1996979899*00010203

Source: Newsweek, October 11, 1999.

It is crucial to anticipate the impact of this great technological revolution. This digital revolution is much more profound than a mere change of tools. The Internet is built on both a philosophical and an infrastructure of openness and free communications. The governments of South Asian Association for Regional Cooperation (SAARC) must adopt a unified, non-regulatory and market-oriented approach to electronic commerce, one that can facilitate the emergence of a transparent, predictable and reliable legal environment to support regional business and commerce.

Official decision-makers, especially in the area of taxation, must realise and respect the unique nature of this medium. They must demonstrate the vision, ability and foresightedness to promote the widespread competition and increased consumer choice. Their role in defining the features of the new digital market place is very important. A great challenge is ahead for them. E-commerce holds the potential to change the entire life pattern. A spirit of sharing is the key issue if SAARC countries want to reap the huge economic benefits of this emerging market.

An historic responsibility rests with policymakers in this part of the world to take swift measures to ensure satisfactory response to the concerns of business and consumers about predictable legal environment governing E-commerce transactions. The concerns about enforcement of contracts, liability, intellectual properly protection, privacy, security, taxes and duties and other related matters are to be addressed and tackled with great care ensuring certainty, predictability and precision.

As the E-commerce expands, there is a growing concern amongst companies and Internet users that governments will impose extensive regulations on Internet and electronic commerce. The most potential area of problematic nature is imposition of taxes and duties. Future legislation by the governments of SAARC will have a profound effect on the growth or retardation of commerce on the Internet. By their actions, they can facilitate electronic trade or inhibit it. Knowing when to act and – at least as important – when not to act, will be crucial to the development of electronic commerce. This paper attempts to present the parametres for the rational taxation of E-commerce to make it a vibrant market place facilitating greater economic cooperation amongst the government and people of SAARC countries. The paper is divided into two parts. The first part deals with general principles necessary for the development and growth of e-commerce and the second part exclusively highlights the issues relating to its taxation.


It is necessary for the growth and development of E-commerce that the private sector should lead the expansion, though the governments should keep on playing a pivotal role in financing the initial infrastructures development of the Internet. Innovation, expanded services, broad-based participation and lower prices grow in a market-driven area and not in an environment that operates as a regulated industry. Accordingly, the SAARC governments should encourage private industry and self-regulations, whenever appropriate, and support the efforts of private sector organisations to develop mechanism to facilitate successful operation of the Internet.

A.        Governments should avoid undue restrictions on E-commerce.

Parties should be allowed to enter into legitimate agreements to buy and sell products and services across the Internet with minimal government involvement or intervention. Unnecessary regulation of commercial activities will distort development of the electronic marketplace by decreasing the supply and raising the cost of products and services for consumers by world over. Business models must evolve rapidly to keep pace with the neck-breaking speed of change in the technology; any governmental attempts to regulate are likely to be outmoded by the time they are finally enacted. Accordingly, the SAARC governments should refrain from imposing new and unnecessary regulations, bureaucratic procedures, or taxes and tariffs on commercial activities that take place via the Internet.

Where governmental involvement is needed, its aim should be to support and enforce a predictable, consistent and simple legal environment for commerce. In some areas, government agreements may prove necessary to facilitate electronic commerce and protect consumers. In these cases, the SAARC governments should establish by consultation and consensus a predictable and simple legal environment based on a decentralized, contractual model of law rather than one based on top-down regulation.

B.        Governments should recognise the unique qualities of E-commerce

The genius and explosive success of the Internet can be mainly attributed to its decentralized nature and to its tradition of bottom-up governance. The same characteristics pose significant logistical and technological challenges to existing regulatory models, and that SAARC governments should tailor their policies accordingly.

Electronic commerce faces significant challenges where it intersects with existing regulatory schemes. It should not assume, for example, that the regulatory frameworks established over the past sixty years for telecommunications, radio and television fit the Internet. Regulations should be imposed only as a necessary means to achieve an important goal on which there is a broad consensus. Existing laws and regulations that may hinder electronic commerce should be reviewed and revised or eliminated to reflect the needs of the new electronic age.

C.        Global status should be encouraged

The Internet is emerging as a global marketplace. The legal framework supporting commercial transactions on the Internet should be governed by consistent principles across state, national, and international borders that lead to predictable results regardless of the jurisdiction in which a particular buyer or seller resides.


The broad framework or the fundamental principles for taxing E-commerce are better enunciated by the so-called “White-House Release on the Global Information Infrastructure”, which are reproduced hereunder:

            “It should neither distort nor hinder-Commerce. The tax system neither discriminates nor should it create incentives that will change the nature of location of transactions.

            The system should be simple and transparent. It should be capable of capturing the overwhelming majority of appropriate revenues, be easy to implement and minimize the burdensome record keeping and the costs for all parties.”

Obviously the main principles, cited above, apply to any tax system in general; be it E-Commerce or otherwise. However, as E-commerce will be a cross border global activity, any discriminatory and or complex tax regime is bound to hinder the growth of this potential economic advance in trade and commerce. Moreover in SAARC countries the tax bureaucracy has a tendency to formulate cumbersome rules and regulations in their zeal to thwart any attempt of tax evasion. Such a mindset may prove a hindrance to the growth of E-commerce. For instance, any administrative dictate by way of complex registration or licencing procedures for E-commerce users, if imposed, may ruin the promotional prospects of E-commerce, which is emerging as greatest conduit for globalization.

A.        Areas of conflict in taxing the E-commerce incomes

Broadly speaking disputes may arise in three basic areas:-

  • Jurisdiction;
  • Access to transactional information;
  • Collection of taxes

B.        Jurisdiction

Determination of jurisdictional authority is not an easy affair in the matter of taxing incomes arising out of E-Commerce transactions as most of the countries follow the principle of domicile or the so-called ‘residence’ criteria as the main basis for determining the jurisdiction. Clearly, this is an inadequate criterion for E-commerce purposes as the commercial activities are taking place without any physical presence or even in the absence of pre-dominant control in the source country. Thus, any taxable entity can use an Internet site from anywhere in the world. For instance a Pakistani businessman using an Internet site from some other country may claim that the transactions executed by him outside Pakistan do not fall under the jurisdiction of tax authorities in Pakistan. However, citizenship criteria helps here and is a valid and workable criteria whereby global income of an assessee is taxed on the basis of his residential status, i.e., a resident or a non-resident which again would depend on the number of days spent by an assessee in one particular country.

In this context, the case of professional incomes of doctors, consultants, technicians and other professionals is further complicated as to the determination of jurisdiction because sometimes the services are rendered in conjunction with the supporting services of fellow professionals like a doctor in ‘X’ country taking a diagnostic scan from a doctor in ‘Y’ country on internet and consulting a specialist in ‘Z’ country on his web-site and then treating or operating the patient in the ‘X’ country on the facilities of a medical institute.

Besides residential jurisdictions, many countries follow the source jurisdiction for determining the taxability of an assessee. Under this system the Source State (i.e. where such property is located) will tax any income from immovable property. The concept of ‘permanent establishment’ is also recognized as a valid criterion for taxing a business entity.

Jurisdiction problem gets further complicated when transactions take place between two countries having different jurisdictional bases, i.e. domicile base in one country and the source jurisdiction in the another. This kind of overlapping may result in double taxation for the taxpayer, which is never intended. These are some simple situations arising in the taxation of E-commerce activities.

C.        Access to information

The transactions taking place in cyber space are vulnerable to deliberate manipulation as the desired information could be withheld or the identity of the parties may be concealed easily. The absence of relevant information may pose big problem for the tax administrators and they may be rendered helpless in tapping a good chunk of incomes emanating to a large number of parties indulging in E-commerce activities.

As a matter of fact the assessee using Internet facility for his business may not have any book-keeping or authenticated documentary evidence of the transactions.

D.        Collection of Taxes

No tax-system is workable unless the requisite taxes are actually collected in order to fund various welfare and economic activities of the State. Therefore, the system of tax collection should be simple and effective so that taxes are properly collected within the prescribed time frame.

The Internet has all the power and capability of an ‘on-line’ link between the assessee and the department and the day is not far-off when the withholding of taxes and other tax payments can be made directly through such Internet access with the department.

E.        Digitalization of tax system

Any kind of books, vouchers and documents are capable of being digitalised, i.e., converted into electronic data. Such an electronic document can be easily downloaded by the user, be it a customer or a tax administrator. “Thus, income-tax returns and a large number of forms and returns prescribed under various direct taxes could also be digitalised and directly downloaded by the income-tax department through the vehicle of Internet. This kind of interactive platform will be most helpful for taxpayers as well as tax administrators.”[3]

F.         Major concerns of tax administration

The technological advancements in general and the development of electronic commerce or E-commerce in particular, according to tax administrators, have the potential of adversely affecting tax revenues of nations, particularly those that fail to keep pace with new technological advances. They have also made the task of taxing e-gains, complex and taxing.

“E-Commerce, for which Internet provides a significant global market-place, is confined not only to trade in traditional goods and services, which it greatly facilitates but handles, in addition, a variety of growing new products that have no physical entity. These E-products include computer software, data and info-products, audio and visual compositions and many other services. All these are capable of production, storage, transmission, sale and even final consumption within cyberspace. E-products are capable of delivery from one place to another, through computer communications, bypassing traditional shopping and transportation methods and the age-old formalities of crossing international borders. All such transactions can be conducted from mobile establishments by anonymous entities and can remain invisible to the physical world. Their books of account can easily be written, amended, erased or rewritten at convenience. It is a kind of hyper-world operation, beyond the laws of physical world.

Internet trade is, therefore, likely to create holes not only in direct tax revenues but also in sales tax, octroi, customs and excise duty collections. The very basis of income tax on cross-border transactions, i.e., source and residence concepts becomes nebulous and permanent establishments vanish in cyberspace. Even within the country tracing Internet transactions could pose serious problems.”[4]


For over 50 years, nations have negotiated tariff reductions because they have recognized that the economies and citizens of all nations benefit from free trade. Given this recognition, and because the Internet is truly a global medium, it makes little sense to introduce tariffs on goods and services delivered over the Internet.

Further, the Internet lacks the clear and fixed geographic lines of transit that historically have characterized the physical trade of goods. Thus, while it remains possible to administer tariffs for products ordered over the Internet but ultimately delivered via surface or air transport, the structure of the Internet makes it difficult to do so when the product or service is delivered electronically.

Nevertheless, many nations are looking for new sources of revenue, and may seek to levy tariffs on global electronic commerce. In USA, State of Texas has already passed a law charging sales tax based on the location of servers conducting the transaction. If the server is located in Texas, all sales made through the server would be subjected to the taxing jurisdiction of Texas. Massachusetts, on the other hand, has declared itself an Internet tax-free zone.

In the face of this controversial treatments and approaches, the SAARC governments should advocate in the World Trade Organization (WTO) and other appropriate international forums that the Internet be declared a tariff free environment whenever it is used to deliver products or services. This principle should be established quickly before nations impose tariffs and before vested interests emerge to protect those tariffs. No new taxes should be imposed on Internet commerce. The taxation of commerce conducted over the Internet should be consistent with the established principles of international taxation, should avoid inconsistent national tax jurisdiction and double taxation, and should be simple to administer and easy to understand. Some economists have suggested a shift from income-based taxation to a system based on consumption. It is argued that even those taxpayers, whose income comes from invisible Internet sales, have to spend it. Some others propose imposition of what is known as ‘bit tax’; a charge on data exchange based on the volume of data transmitted. All these proposals have limitations. It is, however, encouraging to see that countries across the globe have started seeking solutions.


The SAARC States can benefit from the wealth of information from the debate going on in the West regarding specific tax issues affecting electronic commerce. The most important point for this debate is definition of “telecommunications” which is the most popular medium for conducting electronic commerce transactions.

A.        Various Definitions of “Telecommunications”

There does not appear to be a uniform or consistent meaning and definition[5] of “telecommunications”. In some trading blocks such as the European Union, the definition is generally considered to include Internet access provision and e-mail services[6]. The definition includes the sending or receiving of material by electronic or similar communication systems. This may be via cable, fibre optics, radio waves, microwaves, satellite, or copper wire. It covers telephony (system for the transmission of speech and other sounds) and telegraphy (systems involving any process that provides reproduction at a distance of written, printed or pictorial matter) as well as the right to use such facilities. “Content” type services such as information are generally excluded.

The US federal Telecommunications Act of 1996 defines “telecommunications” as the “transmission (1) between or among points specified by the user, (2) of information of the user’s choosing, (3) without change in the form or content of the information as sent and received.” The act defines the term “telecommunications service” as the offering of telecommunications for a fee”. According to the Interactive Services Association Task Force White Paper “Logging On to Cyberspace Tax Policy”, Internet and on-line services[7] defy all these three tests included in the definition above.

Firstly, it is argued that although a user may choose the origin of an on-line service (in terms of the location of his PC), he has no choice or control over where the service actually terminates. Virtually any computer anywhere in the world could pick up the information sent over the Internet. Secondly, an on-line service involves the storage, retrieval and processing of information through electronic means rather enabling users to transmit information of their own choosing. Finally, it is the opinion of many that an on-line information service nearly always involves changes to the information, as files or documents are compressed or decompressed during delivery to the end-user. It is held that even a basic Internet service, such as e-mail, fails to satisfy condition (1) and (3).

Article 2.1 of the World Administrative Telegraph and Telephone Conference, popularly known as the “Melbourne Convention”, defines “telecommunication” as any transmission, emission or reception of signs, signals, writing, images and sounds or intelligence of any nature by wire, radio, optical or other electromagnetic systems.

B.        “Transmission” or “Content”

Given the difference in the various definitions of telecommunications, one can examine the interesting questions of “transmission” or “content”.

In the European Union, an important consideration is that the definition of the telecommunications covers only “transmission” and not the “content”. Otherwise, there could be different treatment of “content” according to the method of transmission (telecommunications or other) and this could lead to distortion in taxation treatment.

In an EU VAT context, the explanatory notes to some Member States, derogations from Article 9 of the EC Sixth Directive, have stated that services such as advertising information provision, recreational and leisure services, although currently supplied through telecommunications networks, should not be included in the definition of telecommunications as these are really “content” type services. These services could be supplied via channels other than telecommunications. In the European Union, there is a view that some services, which are always supplied together or at the same time as telecommunications services, should be brought within the definition. This category includes the transmission of television programmes by cable and satellites for telecommunications and the provision of access to the Internet and e-mail networks. These services would be “transmission” services rather than that of “content” provision.

In the United Kingdom, access to the Internet is included within the definition as a “transmission” type service. However, certain services may be considered as “content” type services in a VAT context, including:

  • the provision of information;
  • consultancy and advice;
  • copyright and licences to use computer software;
  • advertising; and
  • the design of web sites.

In the United States, at the local state sales/use tax level, there also appears to be a similar view that there should be a differentiation between transmission and content. Most US states tax the transmission type services, based on the definition in the 1996 Act referred to earlier. Most states do not tax content type services (for example, data processing or provision of information) unless the services involve the sale of tangible personal property. Again, the problem arises when content is delivered via a transmission type of service and charge for both the services is bundled. A further category known as an “enhanced” service has been introduced as a sort of middle ground between as basic telecommunications service and a pure context service.

The Information Technology Association of America White Paper defines “enhanced services” as follows:

            These services, such as e-mail and Internet access, are distinct from telecommunications services. They are value-added services, the primary purpose of which is to act on the form content, code or protocol of information. They are distinct products which are made available to consumers through the use of telecommunications services. They are not, in and of themselves, communications services.

However, the actual position is not as cut and dried as that, and the debate goes on[8]. From the viewpoint of some US state tax legislators at least, some enhanced services such as Internet access, e-mail, electronic bulletin boards, facsimile services, packet switching and ATM transactions may constitute “transmission” services. This is supported by the view, at least in the United Kingdom following the BskyB case[9], that although the format of services such as broadcasting or e-mail may change during transmission and reception, the basic message stays the same. The content of the message is not altered (or hopefully should not be) by the service provider. Therefore, the tax treatment should not vary whether a message is sent by telephone, fax or e-mail. Some idea as to how the Internet works might be useful in appreciating the technical and specific tax issues discussed in this paper.


According to Article 5.1 of the OECD Model Convention, a permanent establishment (“PE”) means a fixed place of business through which the business of an enterprise is wholly or partly carried on. Article 5.2 includes a place of management, a branch or an office within the definition of a PE.

Should a foreign vendor’s Internet home page on a particular site on the World Wide Web (“WWW”), accessed regularly by customers living outside the said country, fall within this definition of a PE and therefore expose the foreign corporation to local tax.

A.        Is home page on web site a PE?

A home page on a web site could be analogous to an advertisement in a magazine. If a US customer orders a tangible physical item such as a piece of jewellery from a foreign company, there is presently no US federal taxation imposed on the merchant in the absence of an office or an agent in the United States. The result is unchanged even if the merchant advertised in a US magazine. There should be no difference if the advertisement is placed on a web site rather than on a physical medium. The US Treasury’s published aim of tax neutrality would appear to support this view.[10]

Electronic commerce confers “proximity” or “nearness” even though the seller is remotely located and permits him to engage in business without physically entering the tax jurisdiction. Although such a person is unquestionably engaged in business, is he engaged in business in the country where his customer is located? Some commentators offer the view that when a vendor’s home page is downloaded into the random access memory (“RAM”) of the user’s computer, a “place of business” is created. If the web page is downloaded often enough, the activity may be considered habitual and regular enough to be a fixed place of business. However, it is unlikely a web page would constitute a PE under Article 5 of the OECD Model, as it now stands.

The US White Paper attempts to clarify this issue by suggesting that to the extent the activities of a person engaged in electronic commerce are equivalent to the mere solicitation of orders from US customers, without any other US activities, it may not be appropriate to treat such activities as a US trade or business. Going back to basics, Article 5.4 of the OECD Model maintains that the term “permanent establishment” excludes the following:

(a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;


(e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character.

(f) the maintenance of a fixed place of business solely for any combination of activities mentioned in sub-paragraphs (a) to (e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.

Solicitation of orders via a web site may be akin to magazine advertising and is arguably covered by the exception in Article 5.4.e. because advertising is considered many as auxiliary or preparatory in nature. Although there are many similarities to a mail order situation, there are differences also. A mail order vendor has to bear with the many shortcomings of a lack of physical presence such as competing with a rival who has local representation. The latter would be more attractive to customers as they would prefer dealing contractually with a local representative. Thus, the problem of remoteness of conducting business is more acute for a mail order vendor. This is not necessarily the case in the instance of the Internet merchant. Many functions of an in-country sales office[11] can be quite easily achieved electronically. Lack of physical presence is not a handicap but very often an advantage as it enables products and services to be priced more competitively due to fewer overhead costs.

The US White Paper considers the role other activities should play in determining whether a US trade or business exists. A foreign vendor offering computer research services via computers located outside the United States might not be engaged in a US trade or business unless other US-situs activities exist. However, US-based individuals engaged in providing marketing and supporting services for a foreign-based provider of computerized research may create a US trade or business for the foreign person even if the computer servers and other activities are located outside the United States. To the extent a foreign person is not engaged in a US trade or business, the absence of a PE is irrelevant as the United States will not tax that person’s active business income. However, the presence of an in-country computer server owned or used by a foreign company raises the question of whether his equipment might constitute a PE.

According to the Commentary to the OECD Model Convention, a permanent establishment may exist “if the business of the enterprise is carried on mainly through automatic equipment”. The location of the equipment may be the main determinant of presence. An in-country server, owned and maintained by the foreign vendor, might be considered a PE if it satisfied the time requirement implied in the concept of a fixed place of business. Also, more weight might be given to this argument if the type of electronic commerce activities carried on via the server were not in the categories of excluded activities in paragraph 4 of Article 5. In practice, this situation may not arise very often as space on servers belonging to independent third parties would probably be leased.

This issue has been summarised in the US White Paper as under:

            Telecommunications or computer equipment owned or used by a foreign person engaged in electronic commerce raises a question as to whether this equipment could constitute a fixed place of business of the foreign person in the United States, taking into account that there would not necessarily be any employees present. It will be necessary to consider whether a foreign person who owns or utilizes a computer server located in the United States should be deemed to have a US permanent establishment. Again, it is useful to review the treatment of existing, traditional commercial activities and consider whether any existing exclusion from permanent establishment treatment should apply in this situation. For example, a permanent establishment generally does not include the use of facilities solely for the purpose of storage, display, or delivery of goods or merchandise. For a business which sells information instead of goods, a computer server might be considered the equivalent of a warehouse. Examination and interpretation of the permanent establishment concept in the context of electronic commerce may well result in an extension of the policies and the resulting exceptions to electronic commerce.

Even if a computer server hosting an Internet web site is considered a place of business, is it really a ‘fixed” place of business? The web home page might be considered an asset of the foreign vendor. What is frequency of access or number of “hits” required for the web page to assume a permanent presence? It would be extremely difficult to apply these criteria in judging the level of permanence as “local caching” or “mirror imaging” of web sites is possible.

Article 7 of the OECD Model maintains that only profits attributable to the PE may be taxed. Even where a PE is established, attribution of income to the PE would be extremely difficult. There would be valuation difficulties in determining the correct income to be attributed to the activities of a particular PE. The use of linked computer servers which switch signals from one to the other, depending on data traffic intensity, might present further practical difficulties in identifying which servers are used for which activities.[12]

B.        Could a local entity be considered an “agent” of the foreign vendor?

It might be interesting to examine whether an “agency” situation could arise in the following circumstances:

  • the local entity (ISP or telecommunications company) only hosts the foreign vendor’s (content provider’s) web site on its server;
  • the local entity hosts the web site and provides a back-up service (for example, in terms of publicity or marketing) on behalf of the foreign vendor; or
  • the local ISP or a telecommunications company does not host the foreign merchant’s web site but merely provides a connection service between in-country users and the foreign vendors.

According to Article 5.5 of the OECD Model Convention, where “a person (other than an independent agent) is acting on behalf of an enterprise and has, and habitually exercises, in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State… mentioned in Article 5.4 discussed above.”

Agency issues could arise from the relationship between a foreign vendor and an ISP or telecom supplier. In the case of a foreign vendor selling jewellery or even “content” contained on computerized database, it is unlikely that the US ISP or telecom company would be considered “dependent agents” of the foreign merchant, if all they did was to host a web site. The US entities are, presumably, dealing with a number of different customers and are carrying on their business of hosting web sites or as connection providers and are not in the vendor’s business of selling jewellery or data.

C.        Summary

It is clear that mere solicitation of orders via Internet web site, without any other activity, may not result in a PE under the OECD Model treaty. However, in the case of specific treaties where a store or premises used as a sale outlet or for receiving or soliciting orders is included in the definition of “permanent establishment”, this inference may not be correct.

Firstly, the terms “premises” or “store” denote a permanent physical location and an Internet web site can also match these criteria. If held on an in-country computer server, the web site is given a physical location. Secondly, dealing with the level of permanence question, a minimum period of 12 months is prescribed in Article 5(3) of the OECD Model treaty, in the context of a building site or construction or installation project. In fact, this period is even shorter in some of treaties the SAARC countries have with other states. Furthermore, a “warehouse” is also included as a permanent establishment in some of treaties including those with the United States and the United Kingdom. In an electronic commerce scenario, a “data warehouse” or “database” may be used by a foreign entity “in relation to a person providing storage facilities for others.”[13]

It is worthwhile to note that the SAARC scenario is somewhat different from the West. Under the circumstances, all the SAARC countries should in their local tax law declare ISP an agent of independent status.


A.        General

Any type of information that can be digitized (such as computer software, books, music or video images) can be transferred electronically. Although physical goods cannot be delivered via the Internet intangible and information assets are being transferred electronically. Under most tax laws, the tax treatment of payments differs depending upon whether these are for the delivery of goods, the use of intangibles or the provision of services. Electronic commerce makes the distinction between these categories difficult to determine because the items can be instantly and perfectly reproduced electronically by the purchaser.

For example, standard software downloaded on the Internet may be considered as sale of a product and subject to business profits tax. If permission is given for a number of copies to be made, this may be viewed as a limited copyright licence the payments for which may be treated as a royalty subject to withholding tax in the source country. Alternatively, the software may be modified and downloaded to suit a particular user’s application and the resultant income may be considered service fees, without the seller’s representatives having to visit their client on site. Transactions involving digitized information require complex analysis to ensure that neutrality of tax treatment is maintained between conventional and electronic commerce transactions.

Article 12 of the OECD Model Convention defines royalties as “payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematography films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience”. A purchaser wishing to purchase ten copies of a book might purchase these from a publisher, whereas someone downloading a book electronically might purchase one copy and acquire the right to make extra copies. The transaction might be considered as the grant of a limited copyright and the payment might be viewed as a royalty. However, some may regard the transaction as a substitute for purchasing ten copies from the publisher to the extent the purchaser is undertaking to make the copies himself. The US White Paper considers that it is necessary to apply the definition of “royalties” in a manner that takes into account the unique characteristics of digitized information.

B.        Proposed Regulations

The US Treasury has made an attempt to resolve the income classification problem, as far as computer software is concerned, in the form of proposed regulations.

The proposed regulations classify transactions relating to computer software or programmes into four distinct categories:

  • a transfer of a copyright in the computer programme;
  • a transfer of a copy of the computer programme (a copyrighted article);
  • the provision of services for the development or modification of the computer programme; or
  • the provision of know-how relating to computer programming techniques.

A computer programme is defined, for the purposes of the regulations, as a set of statements or instructions to be used directly or indirectly in a computer in order to bring about a certain result. A computer programme includes any database or similar item if the database or similar item is incidental to the operation of the computer programme.

“Copyright rights” are defined as follows:

  • the right to make copies of the computer programme for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease or lending;
  • the right to prepare derivative computer programmes based upon the copyrighted computer programme;
  • the right to make a public performance of the computer programme; or
  • the right to publicly display the computer programme.

A “copyrighted article” is a copy of a computer programme from which the work can be perceived, reproduced or otherwise communicated, either directly or with the aid of a machine or device. The copy of the programme may be fixed in the magnetic medium of a floppy disk or in the main memory or hard drive of a computer.

The “provision of services” involving the determination of whether a transaction involving a newly developed or modified computer programme is treated as either the pro-vision of services or another transaction is based on all the facts and circumstances of the transaction. This includes the parties’ intention (as evidenced by their agreement and conduct) as to which party is to own the copyright rights in the computer programme and how the risks of loss are allocated between the parties.

The provision of information with respect to a computer programme will not be treated as the “provision of know-how” unless the information is:

  • information relating to computer programming techniques;
  • not capable itself of being copyrighted; and
  • subject to trade secret protection.

Where transactions include more than one of the four categories stated above, they should be treated as separate transactions. The appropriate provisions of the proposed regulations shall be applied to each such transaction. However, any transaction that is “de minimis” (taking into account the overall transaction and the surrounding facts and circumstances) shall not be treated as a separate transaction but as part of another transaction.


The impact of electronic commerce on transfer pricing received attention at the OECD Ottawa Conference on electronic commerce in 1998. The Discussion document prepared by the Fiscal Affairs Committee[14] for the conference noted that, to date, electronic commerce has presented neither fundamentally new nor categorically different problems for transfer pricing. However it has the potential to make some of the more difficult transfer pricing problems more common. In addition, as a result of the nearly instantaneous transmission of information and the effect of the removal of physical boundaries, it may become significantly more difficult for tax administration to identify, trace, quantify and verify cross-border transactions.

Specifically, electronic commerce and the development of internet private networks within multinational groups may be seen as putting significant pressure on the traditional approach taken to deal with non-arm’s length transfer pricing, even though the basic nature of the problem has not changed. The paper also identifies the growth of the use of changed. The paper also identifies the growth of the use of these new communications media to small and medium-sized enterprises.

The difficulty lies in the application of internationally accepted methods to the special factual circumstances created by electronic commerce activities. These are, in particular, the increased possibility for specialization, integration of common functions, and cooperation between different locations and legal entities within a multinational group.

The OECD identifies five of the most significant potential difficulties as:

(i)         applying the transactional approach;

(ii)        establishing comparability and carrying out a functional analysis;

(iii)       applying traditional transaction methods;

(iv)       the tax treatment of integrated businesses;

(v)        determining and complying with appropriate documentation and information reporting requirements

Experience amongst tax administrations in dealing with transfer pricing matters in the field of electronic commerce is fairly limited so far. They, therefore, find it difficult to come to firm conclusions without a close examination and a factual description of the elements of electronic commerce. The OECD notes that it may be difficult for tax administrations to perform a detailed examination of the factual background at such an early stage in the development of the business of electronic commerce.[15]

The preliminary conclusion of the OECD Committee on Fiscal Affairs is that the existing guidance in the transfer pricing guidelines[16] is capable of being applied to the special factual circumstances of multinational groups conducting their business through electronic commerce. As a result, traditional transaction methods are still to be preferred as a means of establishing arm’s length prices. However, they accept that where such methods cannot be applied reliably because there is insufficient data on uncontrolled transactions, or such data is considered unreliable, or because of the nature of the business situation, transactional profit methods could be used.

Some of the difficulties in applying transaction-based methods to individual transactions may be alleviated by applying the existing guidance on evaluating combined rather than separate transactions. In addition, in order to be able to identify, trace, quantify and verify transactions undertaken in the course of electronic commerce, it will still be necessary to follow the existing guidance concerning appropriate documentation.

The recommendation of the Committee on Fiscal Affairs is that revenue authorities should monitor developments in electronic commerce to see whether additional guidance on the application of the guidelines is necessary. They raise specifically the question whether existing guidance on documentation requirement needs to be revised for businesses engaged in electronic commerce in order to ensure the necessary availability of verifiable information on transactional data.


In the presently disparate tax treatment of electronic commerce, the following points merit consideration and thorough debate.:

  • SAARC States should initiate some attempt towards adopting a uniform definition of “telecommunications”. This definition might be modelled on an international standard such as the Melbourne Agreement.
  • The difficult issue as to the criteria determining information “transmission” as opposed to “content”, should be tackled as soon as possible. In formulating tax policy in this context, consideration should be given to the fact that with the falling marginal cost of telecommunications, in the future, there is likely to be more commercial emphasis on “content” rather than on the “delivery” mechanisms. A standardized definition of telecommunications might assist in this regard as activities excluded from the definition might constitute “content”.
  • The definition of “permanent establishment” in OECD and other Model Treaties should be amended to take electronic commerce into account. There should be an international agreement (in terms of a code of practice) on the liability or otherwise of Internet service providers and telecommunications carriers, who are sometimes regarded as potential “agents”.
  • Regarding income classification issues, the US Proposed Regulations, which mainly deal with computer software, are a good starting point. However, these proposed regulations might be suitably expanded to cover all digitized information including multimedia broadcasting and content, whether available through the computer or via terrestrial TV, cable or satellite channels. There should be consultation with the OECD in this regard to ensure that uniform definitions are adopted. A special working group should be set up amongst the SAARC countries to consider some of the challenges to existing tax concepts presented by new technological developments as outlined above.
  • There should be some attempt to ensure consistency in fundamental tax concept such as “permanent establishments” between direct and indirect taxes. Presently, there are different definitions of a PE between OECD Model type treaties and VAT legislation which may lead to different results for the same type of service under direct and indirect taxes.
  • Where a tax haven vendor, who receives payment electronically for sales via the Internet, is determined to beat the tax system, a form of withholding tax at the source of payment might be exercised.[17]

As discussed in detail, tax system relating to E-commerce should be simple, certain, predictable and transparent. It should be capable of capturing the overwhelming majority of appropriate revenues, be easy to implement, and minimize burdensome record keeping and costs for all parties. Wherever feasible, the SAARC legislators should look to existing taxation concepts and principles to achieve these goals. No new taxes should be applied to electronic commerce, and SAARC States should coordinate their allocation of income derived from electronic commerce. Of course, implementation of these principles may differ at the sub-federal level where indirect taxation plays a larger role. Before any further action is taken the SAARC governments should cooperate to develop a uniform, simple approach to the taxation of electronic commerce.

[1] The term “electronic commerce”, popularly called E-commerce”, is used loosely to cover a wide field including computer software transactions, electronic retailing, banking, broadcasting via terrestrial TV, cable TV or satellite links, cellular and fixed line telecommunications and any other business activity carried out electronically. It includes business activities carried out through convergence of different types of IT such a computing, telecommunications and broadcasting.

[2] Newsweek, October 11, 1999.

[3] Commerce & Direct Taxes by O.P. Parcek, Taxman, Vol. 101, 1998.

[4] Taxing E-gains can be taxing: Internet v. Tax Net by Manish Gupta, Taxman, Vol. 100, 1998.

[5] Pursuant to the EU VAT proposals of January 1997, telecommunications services shall be deemed to be services relating to the transmission, emission, or reception of signs, signals, writing, images and sounds or information of any nature by wire, radio, optical or other electromagnetic systems, including the transfer or assignment of the right to use capacity for such transmission, emission or reception.

[6] These two categories of services are expressly included within the definition of telecommunications as per the UK budget proposals of November 1996, issued by HM Customs and Excise.

[7] An Internet Service Provider (“ISP”) may provide a basic connection service (e.g. for e-mail) to the Internet. An On-line Service Provider (“OSP”) may have its own proprietary network through which value added services (such as access to newsgroups and forums) may be obtained in addition to Internet access.

[8] Taxation of Electronic Commerce & Internet Transactions, by Raj K. Ganguly, Asia Pacific Tax Bulletin, Volume 3, November 9, IBFD, The Netherlands.

[9] In the UK VAT (Value Added Tax) Tribunal case of BskyB (a satellite broadcasting case) [British Sky Broadcasting Ltd v. Commissioners of Customs and Excise (12394)], it was the opinion of the Tribunal Chairman that the format stays the same. This case involved encryption of TV signals by the satellite transponder on the “uplink” and their subsequent decryption by the end user’s “black box” decoder so that the signal could be unscrambled and viewed. Although many changes to the signal may have taken place on its way from the TV studio, via the transponder to the customer’s home, it was considered that the basic message remained the same.

[10] White Paper: para 6.1.1 of “Selected Tax Policy Implications of Global Electronic Commerce.”

[11] For example, personal solicitations by e-mail mailshots, electronic catalogues or demonstration sample downloads (software, music, games), and contractual agreement.

[12] Taxation of Electronic Commerce & Internet Transactions, by Raj K. Ganguly, Asia Pacific Tax Bulletin, September 1997, IBFD, the Netherlands.

[13] Art. 5(2)(g) of the India- UK treaty.

[14] Electronic Commerce: A Discussion Paper on Taxation Issues (OECD 17 September 1998).

[15] Transfer Pricing & Electronic Commerce, by Jonathan Schwarz, Bulletin, Volume 3, November 7, 1999, IBFD, the Netherlands.

[16] OECD: Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations).

[17] Paper read by Mr. Raj K. Ganguly at the “Multi-jurisdictional Taxation of Electronic Commerce” Symposium held on 5 April 1997 by The International Tax Program, Harvard Law School, Cambridge, Massachusetts, USA.

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