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Online Tax Issues

Adapted from "Legal Issues," by Peter S. Carlisle, in Creating Stores on the Web, 2nd Edition, by Ben Sawyer, Dave Greely, and Joe Cataudella. Carlisle is an attorney specializing in small businesses. You can reach him at

Tax implications relating to Internet commerce are fraught with uncertainty. The dissolution of meaningful geographical boundaries raises questions as to where a taxable event occurs in a commercial transaction over the Internet. While it is difficult to determine with certainty how tax implications will be resolved, it is important for a company to be familiar with the pertinent issues.


In Congress, a bill entitled the Internet Tax Freedom Act was introduced in 1997. The Act set up a national three-year moratorium that prohibits the 30,000 U.S. tax jurisdictions from passing unfair sanctions on Net access, services, and sales, and grandfathered tax codes in effect before October 1, 1998.The Treasury Department published a Discussion Paper, which was a fact-gathering effort designed to resolve the uncertainty about taxation of online commerce. Interestingly, the Treasury Department has advocated a principle of neutrality that rejects the need for new or additional taxes on electronic transactions. It recommends that all income be treated equally, regardless of the means by which it entered commerce. As authority for its position, the Treasury Department notes that foreign businesses are not taxed for soliciting and filling orders from U.S. customers.

In the fall of 1998, the 19-member Advisory Commission on Electronic Commerce was created to study the effect of e-commerce on traditional retail businesses, and the ability of local, state, and international officials to collect taxes on Internet sales. The commission represented a range of stakeholders from AT&T, America Online, an anti-taxation consumer group, and local and state lawmakers.

After some early and expected struggles, the commission released in October 1999 18 criteria for proposed taxation treatments of e-commerce. The commission delivered its final Report to Congress in April 2000. Subsequently, Congress voted to extend the moratorium first introduced in the Internet Tax Freedom Act for another five years. To learn more about the workings of the commission, visit its Web site at

Internationally, foreign companies typically pay taxes on income generated from the U.S. if the income is attributable to a "permanent establishment" located in the United States. Taxation of foreign companies is made possible by treaties with those foreign countries. Under the approach proposed by the Department of the Treasury, a foreign corporation that advertised on a home page would probably avoid taxation. Issues that may arise in connection with international business include how a permanent establishment will be determined, and whether a foreign corporation's use of a United States server will lead to jurisdiction.

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