The virtual world is posing some major challenges for tax authorities, and the stakes are enormous.
If you're having trouble keeping up with new developments in international communications technology and electronic commerce, you can imagine the plight of international tax policy makers. Technology, especially intangible property such as software, can be created, marketed, shipped and paid for over the Internet without any of the standard, auditable traces of the transaction which tax authorities traditionally use. The virtual nature of these transactions renders them "invisible."
Indeed, the very nature of the internet strains the concepts and definitions which tax authorities use to determine what kind of transaction has taken place, whether or not it is taxable, and in which jurisdiction. For tax authorities around the world, the loss of tax I revenue on Internet transactions is regarded as an issue of major concern.
The Internet is international
The Internet is a freely-accessible, worldwide network which companies are using to advertise their products, take orders, and, increasingly, to deliver and to accept payment for goods and services. Internet technology has also spawned intranets and extranets, which provide enhanced intra-company and company-to-company services. As a result of technological improvements and expanded markets, many companies will see the bulk of their future revenue growth arise from international transactions conducted electronically.
The Internet knows no international boundaries, and allows unrestricted access to as many goods and services as can possibly be made available over the medium. The "invisibility" of Internet sales is true of both national and international transactions.
Existing principles of international tax law are difficult to apply in this virtual domain since they generally assume that an international transaction will involve a physical exchange at some point in the transaction. In the new electronic business environment, suppliers and customers can conclude agreements without regard to physical or national frontiers.
Critical tax concepts challenged
"Permanent establishment" is the standard, international legal criterion used to determine a company's tax status in a given jurisdiction by limiting taxation based on residency. Traditional residence concepts are based on criteria such as physical presence, personal and economic relationships, incorporation, and place of central mind and management. Residency, however, is just one of many concepts which do not appear to encompass the diffuse nature of the Internet or electronic commerce
The application of these concepts to the virtual world is uncertain. …