Australian Financial Review – 9 July 2018

Article by Neil Chenoweth


 

As Australia considers new measures to tax foreign online sales, the US Supreme Court has handed down a groundbreaking judgement that signals a radical change in taxing rights over technology companies.

The decision, in South Dakota vs Wayfair Inc (handed down on 21 June 2018), has been described as the most important tax decision in half a century – the biggest tax case you’ve never heard of.

The Supreme Court’s 5-4 decision overturned two previous judgements to find that online sellers, had a physical presence in relevant US states – and thus were liable to pay state sales taxes – even if it was only through cookies, left on customers’ hard drives, or apps downloaded to customers’ phones (see related TT Article on the issues in this case).

While the decision relates only to US states, it comes as moves by the OECD, the European Commission and individual countries including Australia to establish taxing rights over digital transactions come to a head, using similar arguments about permanent establishment (see related TT Article regarding these world wide ‘moves’).

“It is of course a USA case on local laws but the underlying issue is that the recognition that physical presence that has been a touchstone of tax rules is no longer that material,” Clayton Utz tax partner Niv Tadmore told The Australian Financial Review.

Paradigm shift

Most US news coverage has focused on Americans having to pay more for Christmas presents. However the decision is significant around the world, according to associate professor Antony Ting of University of Sydney Business School, “as it suggests a paradigm shift, or a major shift in the thinking of judges in how to deal with the rise of the digital economy”.

The Supreme Court judgement came days before online giant Amazon instituted a geo-block on Australia on July 1, blocking Australian customers from its US site and redirecting them to the local site. That was the day that under new legislation online sellers in Australia were forced to collect 10 per cent GST.

Amazon claimed it was too onerous to collect the tax: “While we regret any inconvenience this may cause customers, we have had to assess the workability of the legislation as a global business with multiple international sites.”

While Amazon is refusing to ship products to Australia, it continues to sell digital products such as books from its US arm, automatically charging 10 per cent for Australian GST in a seamless transaction even for tax amounts as little as six cents.

Amazon is likely to be the major loser from the US court decision – last year it reported $US106 billion of US sales and by next year it is expected to account for half of all US online turnover.

It already pays sales tax in most US states on its own products but not for the estimated $50 billion in sales for third-party vendors.

US President Donald Trump, a vehement critic of Amazon chief Jeff Bezos, who owns the Washington Post, hailed the court decision in a June 22 Tweet: “Big Supreme Court win on internet sales tax – about time. Big victory for fairness and for our country. Great victory for consumers and retailers.”

Physical presence

The Wayfair case re-examined the court’s landmark 1992 ruling, Quill Corp vs North Dakota, which found that as a Delaware company selling floppy disks by post Quill did not have to pay North Dakota sales tax because it had no physical presence in the state.

Since 1992 e-commerce has exploded, enjoying a cost advantage over local businesses that paid sales tax and devastating tax finances. Last year the Quill ruling cost states between $US8 billion and $US33 billion in lost sales tax, the court said.

“In effect, it is a judicially created tax shelter for businesses that limit their physical presence in a State but sell their goods and services to the State’s consumers . . . Each year, it becomes further removed from economic reality and results in significant revenue losses.

“Physical presence is not necessary to create a substantial nexus. Modern e-commerce does not align analytically with a test that relies on the sort of physical presence defined in Quill.”

In reversing Quill, the Supreme Court had ruled that times had changed, Dr Tadmore said.

“Digital commerce has reached critical mass levels from a tax policy perspective,” he said. “You can have ‘substantial nexus’ with a state – and get caught in the tax net – even though you have no physical presence there.”

Even the dissenting judges conceded the Quill decision was wrong and dissented only because they believed Congress should change the law, Professor Ting said.

Significant implications

“This is important as it suggests that there is a major shift in the thinking of how digital economy should be taxed,” Ting said. “This may have significant implications for the push for the digital tax by the European Commission and possibly other countries, including Australia.”

Most tax treaties expressly require physical presence as a precondition to taxable presence, Dr Tadmore said. “The Wayfair logic would render this idea outdated, thereby encouraging countries to renegotiate treaties where physical presence isn’t a precondition to taxable presence.”

While this supports the EC’s recent call for a turnover tax, and Australia’s own digital tax proposal, changing the definition of permanent establishment offers far greater gains for countries though income tax.

After Wayfair, “countries would feel more comfortable to either seek to renegotiate treaties or take unilateral action”.

Nexus rules and profit allocation for digital transactions is the focus of a review by the OECD’s Base Erosion Profit Erosion project due to report in 2020.

“The highly digitalised companies, not all of them but most of them, have been basically sticking their heads in the sands and saying nothing needs to be changed,” Grace Perez-Navarro, the deputy director of the OECD’s Center for Tax Policy and Administration, which runs the BEPS project, said in an interview on June 6 after meetings ahead of the G7 summit meeting in Quebec.

Profit shifting

“All the discussion in the G7, the G20, everywhere you go, this is what ministers of finance want to talk about. We had our ministerial meeting last week and in every single bilateral meeting we had with a minister, this is what they want to talk about.

“So there is tremendous, tremendous pressure. And for those companies that think this issue will go away, it will not.

“As Pam Olsen [PwC deputy US head of tax and former assistant secretary for tax policy at the US Treasury] said at our conference today, ‘The gallows are being set up and so they need to engage in this, because this is happening’.”

In the same joint interview with the Tax Notes Talks podcast, Perez-Navarro’s boss, director of the Center for Tax Policy and Administration, Pascal Saint-Amans, says last year’s US tax overhaul had produced a new willingness to discuss tax reform of the digitalised economy.

“Now given the tax reform there is an opening in the US,” Saint-Amans said.

“They are saying, ‘Well we don’t think that it is appropriate to design a solution for just one sector of the economy, but we do recognise that there is an issue that needs to be addressed and the issue is about the way the allocation of taxing rights is currently decided upon and maybe we should revisit it. And by the way, you Europeans who want to tax Google and the likes, well maybe you would be satisfied by a change there’.”

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