Pricewaterhouse Coopers (PwC) is warning e-businesses to tread carefully when venturing into offshore operations, reminding them that a mere unmanned file server performing any core business function could constitute a taxable presence overseas under new OECD regulations.
John Masters, e-business leader in PwC's tax and legal services practice, commenting on the Organisation for Economic Cooperation and Development's (OECD) December 2000 review of Article 5 of the Model Tax Convention, said Australia is likely to adopt OECD recommendations to tighten tax regulations for e-commerce. (It was under Article 5 of the Model Tax Convention that advanced economy members of the OECD Committee on Fiscal Affairs met to establish a consensus on a global taxing rights).
According to the Australian Taxation Office, while governments worldwide have primary taxing rights, a company has permanent establishment (PE) overseas if its IT equipment is used to conduct any core business activity.
Under new OECD regulations, IT equipment including computers, servers and Web sites -- regardless of whether they are owned or rented for overseas operations -- or part of an unmanned branch or agent operation, are all potential tax items when used to conduct significant business offshore, rather than preparatory or auxilliary activities.
"If 'Company A' has a computer or file server overseas that it has some control over, and through which it performs core activities like sales contracts, online advertising or payment transactions, this can subject the company to substantial tax in the foreign country," Masters said.
Under the OECD decision, Web-based service providers like Internet service providers (ISP) will also be viewed as having a taxable presence where their servers are located.
However, Masters conceded that tax liability is ultimately assessed case by case by individual tax authorities worldwide.
According to PwC, the OECD decision was sparked by governments' fear of tax erosion.
In Masters' view, local businesses are vulnerable to tax surprises offshore, as they tend to assume they will only pay tax overseas on sales revenue, not on operating equipment itself.
And the reality, he says, is that there are few loopholes, except for moving the operation to another jurisdiction or using an ISP for Web-hosting. "Those caught out will be the less informed."
While he could not quantify the extent of taxes e-businesses here face under the OECD's decision, he said small- to medium-sized enterprises (SMEs) were at highest risk of falling into overseas tax traps, as they generally lacked current international tax advice. High-end companies on the other hand were well informed on the implications of operating IT equipment for offshore business, as most had good in-house tax advisers, Masters added.
Naturally, businesses will seek speedy forms of tax avoidance, which, according to Masters, may prompt server farms to proliferate in what he regards as e-business market-leading regions like the UK and US. While the UK is an OECD member, he said it would not treat a single file server as a taxable item due to more lenient government policies. He speculated that the US would take a similar stance, owing to its strong focus on e-business exports.