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TAXING OBSCENE PROFITS:Removing Government
Incentives for Internet Porn
Aldo Forgione, LL.B., LL.M.SJD Candidate, University of Toronto
Faculty of Law
INTERNET COMMERCE
E-commerce involves the purchase and transmission of tangible and intangible goods and services over the Internet
Internet allows local vendors to access global markets with relative ease
The Internet enables consumers to obtain extensive product information and to better compare competitive products
Internet Businesses: The E-commerce Sectors
B2B (business-to-business) sector accounts for 80% of global ecommerce
Businesses often sell, license and transfer rights and goods to related companies
New industries (music piracy and Internet porn) dominate B2C sector
Anonymous nature of the Internet has contributed to growth of pornography
Canadian Tax Treatment of Global E-commerce
Canada Customs and Revenue Agency administers tariffs and taxes at the border for physical goods and collects taxes within Canada
E-commerce businesses “resident” in Canada must pay taxes on net global profits (worldwide income – deductions)
Canada does not collect income tax on most e-commerce sales made by U.S. businesses
Business Contact Threshold
A non-resident may be liable for Canadian income tax if the foreign individual or enterprise is deemed by tax authorities to be “carrying on business” in Canada and earns income in Canada
The threshold for taxation of business profits changes if the foreigner resides in a tax treaty partner country, such as U.S.
Physical Tests in a Digital Age INDIVIDUALS Nonresidents will
be subject to taxation of business profits and income from independent services earned in Canada if they maintain a “fixed base”
CORPORATIONS A foreign
enterprise will be liable for Canadian income tax only if it maintains a “permanent establishment” in Canada
The Reverse Foreign Aid Effect of Bilateral Tax
Treaties Income from e-commerce sales are
effectively exempt from taxation in the country where the sales are completed
Bilateral tax treaties change status quo Tax revenues flow from e-commerce
importing (usually poor) countries to e-commerce exporters (such as the U.S.)
Pitfalls in Taxing E-Commerce Identification difficulties lead to loss
of tax system integrity (tax evasion) and practical problems for tax authorities
Lack of intermediaries eliminates crucial audit and verification points and the usual collection mechanisms for taxes
E-commerce Escapes G.S.T.
GST is a consumption tax, but suppliers of taxable goods and services must collect and remit the tax to CCRA
Imports into Canada are supposed to be taxed but no effort to pursue ecommerce
Goods and services that are exported out of Canada are “zero-rated” (GST exempt)
Internet Tax Freedom
Internet Tax Freedom Act, 1998 enacted by U.S. Congress to encourage e-commerce
Consumption taxes: Tax laws cannot be changed to subject Internet sales to GST, retail sales taxes and other transaction taxes
Income tax: Canada effectively allows U.S. and other foreign e-commerce vendors to avoid paying tax to Canada on profits made in Canada
Implications of Tax Freedom Loss of revenue – other taxpayers must
contribute greater share of “tax pie” Opportunities can be exploited by all
without consideration of product/industry
Internet technology being driven by music piracy and pornographic demand
Violation of tax policy principles
Tax Policy Objectives Do Not
Support Internet Tax Freedom NEUTRALITY
Tax laws should not create artificial biases
Transactions should not be taxed differently solely due to the mechanism for delivery of product
EQUITY Individuals and
businesses in similar situations should be treated equally
“Inter-nation equity” infers the fair division of global tax claims
Tax Avoidance Strategies Used by E-Commerce
Vendors Tax havens and manipulation of tax rules
by transferring profits to low-tax nations Transfer prices among related businesses
exploit unclear tax treatment of web licenses, software and copyright transfers
Vendors adopt entity isolation strategies (shop Walmart.com and save money!)
Canadian Implications of Internet Tax Freedom Loss of tax revenues for Canada Competitive disadvantage to Canadian
businesses that must impose and collect GST while foreign competitors do not
Inequity between consumers that purchase from local outlets and those that shop online without paying GST
Emergence of “Internet Porn” Internet merchants
enjoy comparative economic, legal and tax advantages
U.S. Internet porn industry has grown exponentially
Unknown markets
0
2
4
6
8
Billion $
1975 1995 2000 2005
U.S. Porn Industry
Video Print Internet
Obscene Profits?
The supply of information goods and services over the Internet can provide high marginal returns for e-commerce vendors
0%
20%
40%
60%
80%
100%
Sales (Thousands)
Marg
inal Pro
fit
Proliferation of Internet Porn
Over 100,000 pornographic web sites Illegal porn refers to obscene materials
prohibited under Criminal Code Legal pornography includes lewd or
offensive pictures, writings and images Huge resources dedicated to the
production of Internet pornography
The Crime of Internet Porn
Section 163.1 makes it illegal to use Net to “access” child porn
In 2002 Ontario man convicted of selling obscene materials over the Internet
Economic penalties
Benefits Theory and the Taxation of Internet Porn
Political factors increasingly correlate a particular tax to particular expenditures
The benefits principle of taxation involves considerations of who should contribute to public services and/or social goods
Increased government expenditures for the monitoring of the Internet and enforcement of child protection norms
Remove Tax Incentives for Internet Porn
Level the “playing field” Modify tax rules to
apply to e-commerce Develop digital audit
procedures that work Ensure Internet porn is
subject to taxation like other products
Remove Incentives Foreign e-commerce
to be treated similar to domestic firms
Adopt rules similar to European Union VAT
Taxes may affect e-commerce growth
Predictive Impact of Taxing Internet Porn
SUPPLY SIDE Additional tax,
administrative and compliance costs for Internet merchants will reduce the supply of pornography and shift the supply curve
DEMAND SIDE Equal application of
tax will lead to higher prices for Internet buyers, thereby, eliminating online price advantage and placing downward pressure on demand
Taxation and the Economics of Internet
Pornography The movement of the demand and supply
curves—and the resultant pricing system– will depend on the elasticity of the demand and supply functions within the Internet porn market
Some private porn transactions will be curtailed by the imposition of government regulation
Satisfaction of government revenue objectives will be influenced by relative elasticity –or inelasticity-- of supply and demand over time