Rapid developments in technology, coupled with the ever-increasing popularity of the Internet, have created new and exciting opportunities for E-Commerce companies. E-Companies have a unique advantage over their "bricks and mortar" competitors in that, through the Internet, they are able to largely do away with the need for a physical presence in target countries, thereby revolutionizing traditional sales structures, significantly reducing costs and gaining a distinct edge over their competitors.

The fact that most E-Commerce companies have not in the past, made any significant profits (many of them have in fact been operating at huge losses), coupled with the moratorium on new "internet taxes" announced by several of the world’s leading nations, has led to tax exposure and tax liabilities, if not altogether overlooked, then certainly not positioned at the forefront of most E-Commerce business strategies.

However, as the E-Commerce boom continues, as an increasing number of E-Companies start to realise profits, and as governments around the world begin to devise and formulate tax structures to bring these companies within the tax net, the advantages and motivation for incorporating in and operating out of a low direct tax jurisdiction, make excellent business sense for both the new start-up companies, as well as those established companies wishing to move all, or part, of their business to a low tax jurisdiction.

It must be emphasised that there are very few new E-Commerce tax rules and principles. Rather, existing tax rules are presently applied, largely by default, to E-Commerce.

Before simply "closing shop" and re-locating to a low direct tax jurisdiction, there are of course certain risks and considerations that require thorough evaluation and expert local guidance. Some of these include:

  • Corporate structure
  • Doing business within as opposed to with a country
  • Branch or Agency and
  • Permanent Establishment
  • Withholding taxes
  • VAT
  • Transfer Pricing
  • Threat of revised criteria/rule changes

Corporate Structure

Most of the world’s developed countries exercise their taxing rights by reference to the concepts of residence and source (ie the place where the economic activities giving rise to the profits occur.)

Companies are usually subject to corporation tax, charged in their country of residence, on profits from a trade or business, wherever those profits arise.

There are two main tests for establishing the residence of a company:

  • the place of incorporation; and/or
  • the place of management and control.

While it is fairly straightforward to establish where a company is incorporated - by way of reference to a country’s Companies Registry - it is not always easy to determine from which jurisdiction that same company is managed and controlled. And this can become particularly difficult in respect of E-commerce companies that often have more of a virtual presence than a physical one. Key factors in the determination of the place of management and control are:

  • the location of directors and shareholders meetings
  • the place where the major contracts are negotiated
  • the place where a dominant person such as a managing director or influential shareholder resides
  • the place where company policy is formulated
  • the location of the company’s head office (not necessarily its registered office)
  • the situation of the company’s statutory books and records

To avoid being charged tax in a high tax jurisdiction, it is not enough to simply incorporate the company in a low direct tax jurisdiction. The company, must in addition, be very careful not to be considered to be managed and controlled from a high tax jurisdiction, or it may be considered resident in the high tax jurisdiction and therefore liable to corporation tax, charged by that jurisdiction, on its international trade and business profits.

The E-Commerce company should also be cautious of being considered (through modern telecommunication equipment and the Internet) to be resident in multiple jurisdictions by the tax authorities of each of those jurisdictions, and therefore exposed to multiple tax liabilities.

Doing Business Within A Particular Country

Even if the company is considered resident in the low direct tax jurisdiction, it may still be exposed to source based taxation through its international transactions. The concept of source based taxation gives the country where the economic activities creating the profits occur, the right to levy taxes on the profits arising from trade in that country.

A non-resident company, carrying on business within a country through a branch or agency, may be subject to corporation tax assessed on the profits from that trade.

The term "branch" denotes a physical presence of the company within the jurisdiction, while "agency" denotes a legal relationship, rather than a physical presence. Only those profits derived from the branch or agency will be subject to corporation tax. A typical example of a "branch" is where a non-resident opens an office and employs staff to carry on its business from that office. For "branch" some sort of fixed or permanent establishment is needed, from where a trade is carried on within the jurisdiction. In E-Commerce, the question arises as to whether the physical hardware (ie the server on which the E-Company’s web-site is hosted) constitutes a branch. There is currently no definite answer to this question.

While it does seem that the mere presence of a web-site on a server will not in itself constitute a branch, there is a strong case to be made that a "fully automated" web-site (as opposed to a web-site which is really nothing more than an advertisement or a solicitation to do business), that uses software to conclude basic contracts on behalf of the company, could be considered a branch. As many of today’s E-Commerce web-sites perform just this function, it is advisable, where at all possible, to locate the web-site on a server which is itself located in a desired low direct tax jurisdiction.

As an agency relationship can only exist between two legal personalities, carrying on business through a web-site hosted on a server cannot amount to an agency relationship, and no tax can be charged to the company in those circumstances.

Even where no branch or agency exists the company may be liable to an income tax charge on profits arising from a trade carried on within (as opposed to with) a particular country. Determining whether a business is carried on within a country is largely a matter of fact, to be decided on a case by case basis, but the following general considerations do apply:

  • The place where the contracts or transactions are concluded.
  • Whether there is a dependant agent in that country capable of and authorised to conclude contracts on behalf of the company.
  • The place where the payment is received.
  • The place where the products are delivered.

The place where the contract is concluded is probably the most important (although not necessarily the decisive) consideration.

There are two main common law rules used to determine when and where a contract is concluded, both of which revolve around the acceptance of the offer. The postal rule, which applies to communications by post, states that the contract is effective at the time the acceptance is posted. The receipt rule, which applies to instantaneous forms of communication such as fax and telephone, states that the contract is only binding when and where the communication of the acceptance of the offer is received by the offeror. Generally, communications over the Internet are instantaneous and therefore the rules relating to contracts made by fax or telephone apply.

By illustration, where a consumer in, say, the United States accesses the web-site of a British Virgin Islands company (where the web-site is hosted on a server in the British Virgin Islands), and transmits an offer to purchase products offered for sale on the web-site, and the computer in the British Virgin Islands automatically sends notification of acceptance of the offer, the contract is concluded in the United States. As this indicates that the British Virgin Islands company is trading within the United States (being the country where the contract was concluded), the Company may be liable to pay income tax, in the United States, on the profits arising from that transaction. It is therefore essential that the company’s standard trading terms stipulate that the contract is formed in the British Virgin Islands. It must however be noted that such a standard trading term, although influential, may not always be conclusive evidence as to where the contract was formed.

The company will need to carefully consider whether it is necessary to have any type of a physical presence in target countries, including a marketing presence, a customer support center or a warehouse for the storage and distribution of goods. As a general rule, to avoid being considered as trading within a country, any physical presence should be kept to a minimum.

Permanent Establishment

As mentioned above, in the absence of a branch or agency, a non-resident company may be liable to income tax on the profits of a trade carried on within a country. However, where a tax treaty exists between the residence and the source country, the source country usually gives up its taxing rights in favour of the residence country, with the exception of income which is attributable to a Permanent Establishment in the source country. Therefore, unless the income is in some way attributable to, or derived from, a Permanent Establishment in the source country, the income will only be taxed in the country of residence.

Article 5 of the OECD Model Tax Convention defines a Permanent Establishment as a "fixed place of business through which the business of an enterprise is wholly or partly carried on", and includes the presence of a dependent agent and a branch as a Permanent Establishment. However, most tax treaties exclude from the definition of a Permanent Establishment functions and activities which are merely preparatory or auxiliary to the activities of the company.

A topical, and somewhat controversial question, is whether a web-site hosted on a server amounts to a Permanent Establishment. As with "branch", there are differing viewpoints on this question - which is to be expected as many international trade and economic organisations, and governments have generally not as yet formulated final E-Commerce policies. Again we would advise a company to host its web-site on a server located in a low direct tax jurisdiction.

It must of course be remembered that there are not many tax treaties involving the traditional low direct tax jurisdictions, and the writer is not aware of any tax treaties with low direct tax jurisdictions of practical use within the E-Commerce context. Without the assistance of a tax treaty to minimise the tax risks associated with carrying on business within a target country it follows that the structure of the company, at all levels, must be carefully considered so as to minimise any exposure to high source based taxation.

Withholding Tax

In certain circumstances a person making a payment to a non-resident owner of copyright is required to deduct income tax at source. This is called "withholding tax". Under the OECD Model Convention income from license fees is almost always subject to withholding tax in the source country, while business profits, unless attributed to a Permanent Establishment in the source country, are only taxed in the country of residence. There is uncertainty as to whether income from particular E-Commerce transactions (e.g. downloading of software or other digitised material) is a license fee / royalty, or business profits. The OECD has modified article 12 of its Model Convention in an attempt to clarify this. Where only the rights to use the digitised material are transferred the income from that sale constitutes business profits. Where rights to reproduce, adapt and/or re-sell the material are transferred the income constitutes license fees and withholding tax will have to be deducted.


In the UK (and other member states of the European Union), VAT may be charged in respect of the supply of certain goods and services. In determining whether a VAT charge applies, the place of supply of the goods or services is important.

In order to avoid a VAT charge totally, the E-Company must ensure both that the supply is deemed to take place outside of the UK and the supply is not received in the UK. Where a "relevant service" is received within the UK by a business user, a VAT charge will be applied and the UK business user will have to account for VAT on the supply. "Relevant services" include: transfers and assignments of copyright, patents, licences, trademarks and similar rights; advertising services, banking, financial and insurance services; and data processing and provision of information.

With modern technology many services can be performed entirely over the Internet. A supplier wishing to target a market in the European Union may be more competitive by locating outside the European Union, where the supply of services will fall outside of VAT.

The current VAT system was not designed with E-Commerce in mind and it is likely in the near future to be amended, both to ensure that the authorities are able to effectively collect VAT from E-Commerce transactions and also to level the playing fields between non-European Union suppliers and European Union suppliers.

Transfer Pricing

Companies sometimes enter into transactions with associated parties, on a cross border jurisdiction basis, to take advantage of disparities between national tax systems. These transactions are the subject of increasing scrutiny by tax authorities throughout the world.

The existing principles of transfer pricing apply to E-Commerce. The historical approach has been to identify the transaction itself and then value that transaction by applying "arm’s length" criteria. This either leads to an adjustment of the value of the transaction, or an adjustment and/or re-characterisation of the nature of the transaction, particularly where the terms and conditions of the transaction differ from those that would be expected between parties dealing at arm’s length.

The problem with the arm’s length test, as it applies to E-Commerce, is that it relies on comparable transactions between unrelated parties to establish an arm’s length criteria. And with E-Commerce there aren’t always comparable transactions. In addition the tax authorities have particular problems identifying these transactions due to the ease with which goods and services can be transferred electronically between jurisdictions. This has lead the authorities to make increased use of profit splits between related companies. However, this raises further problems for the authorities because revenue and expenses (particularly in respect of the development of digitised products) can be easily moved between jurisdictions.

Revised Criteria And Rule Changes

Governments around the world are clearly concerned that E-Commerce will erode their traditional tax bases, and there has been talk from some governments that they may well adopt unilateral rules to deal with, what is essentially, a global issue. This has caused great concern amongst certain economic organisations, and in particular the "OECD".

The OECD is playing a particularly pro-active role in attempting to formulate international consensus on E-Commerce tax issues, aiming for neutral and equitable taxation between E-Commerce and conventional forms of business. It has, to its credit, recognised that E-Commerce is in its infancy and needs flexible and dynamic tax solutions to ensure authorities keep pace with the fast evolving technology that is driving E-Commerce. The OECD is currently considering a wide range of tax issues, varying from how to attribute profits to a Permanent Establishment to the characterisation of various types of E-Commerce payments so as to distinguish between payments for the provision of services or income from sales and royalties - essential in determining the relevant levels and types of taxation.

There is much uncertainty currently surrounding the tax treatment of E-Commerce, causing enormous frustration for both tax advisors and E-Companies alike. But one thing is for certain: the current tax rules certainly will (and need to) change. Traditional tax principles were of course never designed with the Internet in mind and are hopelessly inadequate to cope with the technological capabilities at the disposal of today’s companies. They simply do not work within the E-Commerce context. As governments see their revenue bases dwindle, new tax regimes will be established to ensure that: (1) the authorities get their slice of the E-Commerce action and (2) that traditional forms of business do not suffer more onerous tax responsibilities than their E-Commerce competitors. Whether they are able to achieve this, and whether the various countries buy into the OECD solutions so as to adopt a truly global approach to the taxation of E-Commerce, remains to be seen.


Although tax considerations should not be the principal considerations in the location of any business, they are nevertheless, very important considerations, to be taken alongside legislative, regulatory, telecommunications, employee issues etc.

However, when one considers that digitised and other intangible products and services can be sold and delivered from low direct tax jurisdictions to consumers in target countries throughout the world, technically and logistically just as easily as if the company was itself located in that target country, the significant tax advantages of doing business from a low direct tax jurisdiction cannot be overlooked, and should certainly be carefully evaluated by companies wanting to maximise profits and compete effectively, in what is fast becoming a highly competitive, cost sensitive industry.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.