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 Welcome To Cyberspace . Your Papers Please? By Bill Frezza About a year ago, the Treasury Department issued a little-noticed discussion document entitled "Selected Tax Policy Implications of Global Electronic Commerce" (www.ustreas.gov). Beavering away in obscurity, these unelected technocrats have almost finished turning the broad "implications" into detailed regulations. Like most tax rulings, these regulations require no further congressional action to have the force of law. So, while rehabilitated Clinton apparatchik Ira Magaziner was out mesmerizing the digerati with his "Framework for Global Electronic Commerce," promising free markets and no new taxes, the green-eyeshade boys were quietly laying the groundwork to launch the IRS into cyberspace. The new regulations are being promoted as a means to develop uniform rules by which software distributed over the Internet is to be taxed, particularly when distribution occurs across national borders. This has been a nagging issue for software publishers worldwide who, when they aren't busy fighting pirates, must worry about the threat of double taxation for electronically distributed material--paying income taxes in the country of origin as well as royalty taxes in the country of sale.
So how will foreign governments be brought into line with this policy? A Treasury attorney with whom I spoke indicated that the United States is prepared to lead an effort to achieve "global consensus." What goodies will we offer to coax foreign taxing authorities into going along? And how will the problem of Internet tax havens be dealt with--a looming issue in digital commerce--as it becomes ever easier to set up remote servers that can distribute content from almost anywhere? Speak Software and Carry a Big Stick One answer being considered will bring a chill to privacy advocates, especially because Treasury has announced intentions to expand the initial regulations covering software distribution to cover all forms of digital content: text, music, video, photos--you name it. The fundamental problem with collecting taxes in cyberspace is that bits are bits. Who knows what is really flowing over those T3 lines? Customs or postal inspectors can easily pry open a package to see whether the contents include a CD, a T-shirt or a bundle of greenbacks. But how is this job to be accomplished on the Internet, especially since, as the Treasury Department so quaintly observes, "the use of encryption could preclude comprehension." The classic strategy of forcing reporting requirements on key "taxing points," such as banks, clearinghouses and other financial institutions, is not likely to work as the need for intermediation on the Internet will be vastly reduced. In many ways, that's the whole point of electronic commerce. Any reporting burdens must be pushed out to the end points of each transaction. How will this be done? This is where Big Brother may arrive big time. Under active consideration is a plan to require taxpayers to obtain digital IDs for all electronic transactions, keeping records that could be examined on audit. The IDs would be issued by IRS certified agencies, subject to government developed standards to ensure that proper identity checks are performed before anyone is allowed to shop online. The IRS would enforce this by issuing its own digital certificates to issuers of digital IDs so that they can electronically prove that they have received IRS certification. The technology they need to m ake this happen is available. All that's missing are the regulations forcing compliance. So, stay tuned. If you enjoyed the encryption key escrow debate, you'll love this one. Bill Frezza is a general partner at Adams Capital Management. The opinions expressed here are his own. He can be reached at frezza@alum.MIT.EDU or techweb.cmp.com/nc/frezza/frezza.html.
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Resolution of this issue would no doubt be welcomed by the industry. The solution that will be proposed by Treasury before the end of the year comes down on the side of subjecting software publishers only to income tax, exempting them from foreign royalty taxes. This works to the advantage of governments from countries that export more software than they import, a fact that will not go unnoticed by our trading partners.