Curious welcome by Inland Revenue for e-commerce tax proposals

Dawn Primarolo said:

“This is a global issue and no one country can afford to 'go it alone'. It is important for countries to work together and the efforts of the OECD are to be welcomed, especially the way business has been involved in the work. I am particularly grateful that the UK has been able to provide a lot of input into these final reports.”

However, the Inland Revenue has indicated that it will ‘go it alone’ on one of four proposals agreed by the OECD which consists of the 30 leading industrialised nations in the world. The proposals are on how to apply a rule under international tax treaties that determines a country’s right to tax profits from e-commerce.

In the UK and the other OECD countries, the profits of any business are taxed wherever it has a “permanent establishment”. Until now, there has been some ambiguity about the taxation of internet businesses. This is because these companies can operate in one country but locate the servers that host their web sites in a different country. The question arose, does the location of a server in another country constitute a “permanent establishment”? The OECD members agreed this month that it should – but the UK disagreed.

The OECD countries agreed that a web site in itself cannot constitute a permanent establishment. Also, where, for example, one company’s web site is hosted by an internet service provider, the service provider’s hosting will not create a permanent establishment for the company paying the service provider, except in very unusual circumstances. The UK agreed with these points.

Most significantly, the OECD also decided that the place where computer equipment, such as a server, is located can amount to a permanent establishment for a company, provided the purpose of the server is significant and an essential part of its business. The UK government disagrees with this part of the OECD’s decision. Nevertheless, the decision can now be considered a tax rule in all OECD countries except here. It is not a new tax law but simply an agreement on how to interpret existing laws. So the effect of the announcement is immediate.

The upshot of the OECD decision is that in most of Europe and the US, but not in the UK, the location of a server which hosts a web site is likely to lead to a tax liability in that country if it takes orders from on-line customers or if it processes credit card details. This is because these functions are likely to be essential to the business activity.

John Salmon of OUT-LAW.COM said:

“If a business pays an internet service provider to host its web site, it probably won’t be affected by the OECD decision. But many internet businesses with large web sites use their own servers or rent servers from third parties to host the site. Internet service providers themselves should also take note because it could affect them.

“There is now an incentive for any UK business that owns or rents a web server overseas to relocate its equipment in the UK if it would not otherwise go through the expense and hassle of completing tax returns elsewhere.”

In today’s announcement, the only reference to the UK’s differing position was a footnote by the Inland Revenue saying that:

“The UK… stands by its point of view that in no circumstances do servers, of themselves or together with web sites, constitute permanent establishments of e-tailers. This view will provide certainty on a complex issue on which business has been consulted and fully supports.”

Further information is available on the OECD’s web site