Cybertaxes.

If not addressed early and appropriately, tax issues can add risk and reduce profitability for an electronically enabled business

The explosive growth of the digital economy allows commercial transactions to occur in a world without borders and in the blink of an eye. E-commerce can be the modern- day key to successful international trade and cross-border co-operation, not only within an organization but also in the business-to-business environment. New businesses proliferate at a rate previously unimaginable, leading to an infinite number of transactions between e-business participants of all types and magnitude. E-commerce greatly reduces the need for a physical presence in a jurisdiction and the number of intermediaries necessary to complete a transaction.

Despite these benefits, financial, legal, organizational and technical issues abound in considering e-business commerce that transcends borders. Businesses without borders raise confounding tax compliance and collection issues for governments, regulators and the e-businesses alike. Generally, the broader issue of cybertaxes is framed by three key words: uncertainty, risk and, most importantly, opportunity.

When it comes to taxation of these new electronic transactions, there are generally two diametrically-opposed camps. One group believes www stands for Wild Wild West, and is convinced the Internet should be a tax-free zone. The other sees no reason to treat an e-business any differently -- or more favourably -- than a traditional storefront operation. Coincidentally, tax authorities also grapple with the inadequacy of tax systems built in the pre-electronic era, suggesting that a global consensus on cybertaxing is unlikely to emerge any time soon.

Canada is actively studying the issue -- reviewing its fiscal policies and collection procedures -- but governing guidance remains scant. In general, Canada's position is more similar to the U.S. than European nations. The latter tend to favour stricter regulation, including the registration of certain nonresident e-businesses for tax purposes.

In Canada and the U.S., indecision has essentially created a standstill environment with regard to taxes and e-business. In 1998, the U.S. Internet Tax Freedom Act legislated a three-year moratorium on new and discriminatory taxes pertaining to e-commerce. Legislation is now before the U.S. Senate to extend that moratorium for another five years.

Even such influential bodies as the Organization for Economic Co-operation and Development are splitting hairs over such vexing issues as "taxable presence" -- simply, whether a Web-based business is really a permanent establishment and thus subject to income tax, and whether a Web server alone should constitute a place of business.

Online operations are a moving target, marked by incompatible tax treatments for domestic, international, sales and customs purposes. For precisely these reasons, how an e-business conducts itself and interprets existing tax principles is crucial if it is to minimize its tax footprint and take advantage of the available tax opportunities.

How a digital-age venture hires, fires, locates its operations and chooses its partners can create tax liabilities or add value, as can the way it defines, prices and distributes its product. Locating key functions in lower-tax jurisdictions, for example, can yield significant savings.

Consider this: when digital products -- online books, newspapers or streamed videos, for example -- are accessed via the Internet for a onetime viewing, the end-user may be entering into a licensing agreement with a non-resident. The royalty income earned raises the issue of whether the payment should be subject to withholding, sales or income taxes, and, if so, which jurisdiction has the taxing prerogative.

Rules regarding place of contract, place of supply, and generally whether a transaction constitutes "carrying on business in Canada" must be examined carefully. These factors are critical when applying the GST to both Canadian residents and non-residents. Non-residents transacting electronically with Canadians will have to consider whether their activities can be construed as a transaction subject to GST.

When designing Web sites or e-business models, companies need to be aware of registration, collection and filing requirements. Moreover, they must be sure they are asking for and collecting the right information with respect to federal and provincial sales taxes, U.S. state and local taxes, and European value-added taxes.

Much confusion is engendered by the divergence in tax treatment from jurisdiction to jurisdiction. Many companies may be unaware that even advertising on the Internet can create a taxable presence in some American states. Similarly, in Canada, if a Web ad created by a company in British Columbia is aimed at consumers in the Quebec market, it may be obliged to register for Quebec sales tax, even though it has no physical presence in Quebec.

Until major consensus is reached between taxing jurisdictions, it will be essential for companies to monitor the tax implications of how they conduct e-business. Left as an afterthought, tax considerations can add risk and reduce profitability for an electronically enabled business. However, when addressed early and appropriately, responsible e-business taxation strategies can bring benefit and competitive advantage.

Pierre Bourgeois is the Canadian tax e-business leader for PricewaterhouseCoopers LLP. His insights on e-commerce and taxation issues have previously appeared in The Globe and Mail.