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

Future Prospects of E-Commerce Taxation

E-commerce can be encouraged through the use of targeted tax incentives

Benefits principle of taxation could be invoked to extend special user fees and tax levies (like fuel taxes) to pornography

Taxation: An alternative to censorship?