Corporation Tax and e-Commerce - Bahamas Business Guide

Corporation tax (income tax) is levied on the profits of an incorporated business. Some countries tax companies based on place of incorporation (legal establishment), but more usually tax applies to a 'permanent establishment'. As with individuals, the taxing country will normally attempt to tax a company's world-wide income once it has demonstrated permanent establishment. Income arising in other countries is often subjected to local withholding taxes before remittance; or of course it can easily happen that more than one country will assert permanent establishment, leading to double taxation. These situations are sorted out through the network of double taxation treaties which most high-tax countries have entered into.

IOFCs, International Offshore Financial Centres, by and large do not have double tax treaties, not least because they usually have very low or no corporation tax. Companies have often attempted to escape tax by earning profits in subsidiary companies in IOFCs and not remitting it to the mother company; almost all high-tax countries have anti-avoidance 'controlled foreign company' laws which attribute such income to the mother company.

Within this (highly over-simplified!) framework, what is the effect of e-commerce? Whereas previously, in order to trade in a country, it was necessary to have some or all of staff, an office, a warehouse, and means of delivery, these things can be to some degree avoided with e-commerce. A customer can inspect and buy goods or services on a company's Internet site (no local record of the sale is created), using money from an offshore account or an electronic credit card (no local trace of the transaction is created), and delivery of the goods can be outsourced to a third party. In fact, in most countries, a simple warehouse and delivery operation does not constitute a permanent establishment so that the outsourcing may not be necessary.

The placing of the Internet server from which (on which, if you like) the e-commerce transaction happens, is probably important: some cases have already suggested that a server may constitute a permanent establishment; others suggest that it doesn't. Of course, the server can be anywhere, and specifically, it can be offshore. If the goods or services are deliverable digitally (eg music or software) then there is no physical trace whatsoever of a transaction in the jurisdiction which would like to tax it.

The OECD has established a working party to study the question of web servers and the possible need to re-define the concept of the permanent establishment. It has conducted two rounds of consultation, the second having closed in June 2000, and is expected to bring forward recommendations at its meeting in September 2000. Its interim report seemed to be moving in the direction of agreeing that servers would not constitute permanent establishments.

As well as 'dematerialising' transactions, the Internet allows a company to have its various departments scattered almost anywhere, but permanently connected through the web. It will become increasingly difficult to say exactly where a company has its 'main' base, because it often won't have one. In an extreme case, a company can base itself entirely in one or more IOFCs, outsourcing all those elements of its business which require physicality. For this reason, the OECD's agenda includes the question of whether the concept of the permament establishment is now outmoded.

Governments, which haven't so far been much affected by e-commerce, are nonetheless very concerned about the future. How can a Government collect tax on profits resulting from transactions which it can't see or measure, carried out by a company which doesn't exist physically on its soil? Intrusive and heavy-handed attempts to 'police' the Internet or its use have already been quickly seen off, and most Governments seem to understand that such behaviour will simply result in the isolation of their countries from the rest of the world.

Of course, eventually a solution will be found to tax Internet transactions in a fair way, and it is no doubt correct that this should be the case; but while the search continues there are going to be multiple, completely legal ways for companies to take advantage of the confusion in order to reduce their tax bills.


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