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THE TAX MAN COMETH TO CYBERSPACE

Governments want a piece of the pie. But what will work?

The hot new trend in business today is figuring out how to make big bucks in cybercommerce. And that's spawning a hot new trend among governments: figuring out how to tax cybercommerce.

Right now, buying and selling through the Internet is small potatoes, generating a mere $500 million a year. But the Net's potential for growth is enormous. That's why governments worldwide are looking for ways to tax both Internet service providers, such as America Online Inc., and the transactions that take place in cyberspace. Even states in the U.S. have joined overseas lawmakers in the struggle to figure out how and where to tax techno-transactions.

NO MARGINS. Timing is crucial. Governments have a real chance to establish uniform rules while Internet commerce is still modest. If they miss this

opportunity and allow various jurisdictions to try to grab as much tax as possible, the resulting patchwork of laws may stifle the growth of a young industry. ''For many companies, this is a no-margin business,'' says Bill Sample, senior director of tax affairs for Microsoft Corp. ''Imposing taxes on gross revenues is not going to encourage people to expand.''

A Nov. 21 Treasury Dept. report sets out U.S. policy for the first time: As much as possible, apply existing tax rules to transactions on the Net, protect companies from being taxed in two jurisdictions for the same transaction, keep things simple and uniform, and resist new tariffs on downloaded goods and services, such as software. Says Deputy Treasury Secretary Lawrence H. Summers: ''This is a case where tax policy is trying to support the development of a technology, not impede [it].''

As far as they go, those guidelines will please most U.S. companies. ''Treasury has made it clear that it doesn't intend to create new rules,'' says Carol Dunahoo, a principal in the National Tax Services Group of Price Waterhouse. But she warns that ''there remains a lot of uncertainty about how existing rules apply.''

One critical issue will be whether cybertaxes should be imposed based on the residence of buyers or of sellers. Concerned about the difficulty of identifying buyers and well aware that most producers of Net-based goods and services are headquartered in the U.S., Treasury wants to preserve its right to tax the sellers of goods over the Information Superhighway.

Large U.S. companies, many of which pay lower taxes overseas, have other ideas. And so do many nations which prefer to levy their own taxes--both as an easy way to raise revenue and as a means to protect local high-tech businesses from powerful U.S. competitors. Says Dennis Glover, tax manager at Deloitte & Touche: ''Developing countries and those that want to create their own markets will make it as onerous as possible'' for foreigners who try to sell over the Net.

The European Community is under pressure to take just that route. Concerned that U.S. operators are dominating Europe's market for Internet access, homegrown competitors want U.S. sellers hit by local value-added taxes in the countries where their customers reside. ''These are complex and politically very sensitive questions,'' concedes an EU official.

A similar conflict may also be cropping up between the U.S. and South Korea, where local businesses that acquire licenses from foreign parents to copy and sell software are subject to hefty Korean withholding taxes. But a new U.S. Treasury proposal could bar American software makers from claiming foreign tax credits for the deals.

Many U.S. companies have tax problems closer to home. State governments, eyeing huge potential revenues, are scrambling for ways to impose their own levies on the Net. At least a dozen states, from California to Florida, are actively considering new cybertaxes, including excise and special telecommunications taxes.

Service providers, of course, would love to avoid new taxes altogether. Barring that, operators would like to see states make three concessions: impose cybertaxes in the same manner, require customers to pay taxes directly, and refrain from levying additional telecom taxes. ''If states do impose taxes,'' says Russ Kennedy, CompuServe Inc.'s manager of government and industry relations, ''we want to be sure they are fair, uniform, and simple.''

The industry may have a powerful ally in Representative Christopher Cox (R-Calif.), chairman of the House Republican Policy Committee. He's mulling legislation to freeze new state cybertaxes. ''This is interstate commerce, pure and simple,'' Cox warns. ''States should not be allowed to privateer against interstate commerce.''

PAY PER BIT. While business fears complexity and double taxation, governments worry that tens of billions of dollars in sales will evade taxation. On the Net, where a product can be downloaded to an E-mail address and paid for with a credit card or electronic money, it's very hard to trace buyers. And that opens up big opportunities for tax avoidance.

Behind all these issues is one fundamental question: Where exactly is the Net located? Normally, a state or a country can impose taxes on a business that has physical presence in its jurisdiction. In simpler times, that meant a store or an office. Not anymore. Internet service providers, for example, want their customers to get on the Net with a local phone call. To do that, operators have hundreds of modems, telephone switches, and other pieces of communications gear scattered throughout the U.S. and the world. Mostly leased from phone companies, the equipment could easily fit in a closet. But some governments claim that's all they need. California officials say that merely putting up a Web page on a server located in their state could make companies subject to taxes.

Some nations are mulling ways to take that idea one step further. Both Italy and Belgium are considering a ''bit tax'' that would impose a levy on every scrap of data that crosses the Net in their countries.

Fanciful? Perhaps. Unenforceable? Probably. But governments see the economic potential just as clearly as business. And where money is being made, taxes can be paid. Electronic commerce is just beginning to blossom--and so is the debate over how to tax it.

By Howard Gleckman in Washington, with Marsha Johnston in Paris and Catherine Lee in Seoul


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Updated June 14, 1997 by bwwebmaster
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