The Boundaries of e-Commerce

Governments around the globe have begun to grapple in earnest with the legal ramifications of the Internet and e-commerce. As regulators revisit a host of issues-taxation, criminal enforcement, and privacy issues-relating to this challenging new medium, the industry glances nervously over its shoulder, uncertain how the wheels of government may impact business opportunities. The outcome may impact not only the short-term future of e-commerce, but the future of world economies as well.

We discuss the possible actions governments might take in regulating Web commerce-and the possible reactions on the part of e-commerce companies-with Douglas Graham, Managing Director, Electronic Commerce for KPMG. Graham has twenty years of experience in the design and implementation of electronic commerce systems in the financial and information industries. He is the author of numerous papers and has testified in the United states Congress on international issues relating to electronic commerce.

Q: Last year there was tremendous optimism about the Internet. What do you think the climate is now?

A: Of course there was optimism; there was an adjustment. Everyone expected that. That now makes people feel that there's more substance as we move forward. A lot of the very speculative element has been taken out. But there is the understanding that there's going to be a massive restructuring of the industry in all sectors, and that this is going to be enabled through e-commerce. There is a lot of optimism, but it is a little more muted than the heady days of a year ago.

Q: Do you think that, given the recent correction in the market, governments will focus less on regulation than on bolstering the industry?
A: I think governments may have a slightly schizophrenic view of the Internet market. The answer will vary according to whether we're talking about G7 nations or G77 nations. But starting with the G7 nations (which of course now are G-8), they see future growth coming from the SMEs [small/medium-sized enterprises]. But, on the other hand, [these governments] worry about their long-term ability to control and tax that growth. E-commerce is beginning to transcend national borders. It's relatively easy for [an e-commerce company] to adjust its jurisdiction. Meaning there's going to be jurisdictional competition for hosting these new portions of the e-commerce growth economy.

We've participated with some of the government groups trying to figure this out. FINCEN (Financial Crimes Enforcement Network) has its particular concerns; the Federal Reserve has its; and the tax collectors have theirs. All of these entities foresee real issues-both with some businesses migrating away from their jurisdictions and with the phenomenon we call offshore-onshore. This is where companies start acting almost as if they're offshore, because they're able to encrypt their servers or locate on Indian reservations.

Q: Where do most of these governments stand on taxing the Internet?
A: In Europe, they're looking at adding a VAT tax on online services, while the U.S. is specifically exempting the online services from any kind of additional taxation. But even though they're not collecting any specific taxes on the online transactions, [governments] are getting corporate taxes and employee-related taxes from these companies.

Q: A lot of e-commerce companies are not showing profits. Is taxation going to slow down the industry?
A: I think it could slow down. Not because of the tax itself, but because of the cost of compliance with those taxes. If you're offering something online for sale in the U.S., you're effectively dealing with about 36,000 or 37, 000 different taxing jurisdictions. You need a pretty sophisticated operation to be able to handle that. When the taxes are raised for these small start-ups, which are not particularly profitable, it's nominal.

Q: What is the taxation climate in Europe? You mentioned the VAT tax on e-commerce. Has that been implemented?
A: I was over there last week, and I saw a bill being introduced that would impose that kind of tax, and it looks like it will go through. The climate is much more accepting of those kinds of taxes because it's so much more of the tax base in Europe. But the tax issue is just going to be tough, because it's very easy (it's even easier in Europe) to change your jurisdiction to somewhere that wouldn't be affected by that. Go to Luxembourg or Switzerland or Lichtenstein. All of those countries are very interested. A lot of the countries that have traditionally been viewed as tax-treaty countries are now realizing that they have a window of opportunity here.

Q: Do you expect e-commerce companies to relocate?
A: Yes, it is happening. In a lot of the jurisdictions you see early companies starting out. Some of them are getting government support. We've had calls [at KPMG] from a lot of these governments saying, "How can we reposition ourselves to be a haven for electronic commerce?" They see it as much more positive. Because of the multi-lateral statutes against money laundering, there's much more pressure coming down on their traditional business of very discreet capital storage. E-commerce represents a more positive opportunity--providing a favorable regulatory environment for e-commerce companies. If you like, they're the Delawares of the world. Delaware has 47 percent of the Fortune 500 corporations because it set up a very favorable body of jurisdictional laws, statutes and arbitration proceedings. These opportunities now exist on a global basis for companies.

These jurisdictions are in position to adapt their laws very quickly. I call them agile nations. Take Bermuda, where they've passed several private member bills facilitating electronic commerce. They're much more agile, much more able to move. It takes [the U.S.] a long time to get anything through. In these jurisdictions, you can get something through in three months. For around $27,000. It's an interesting new model of government, isn't it?

Q: The term, "country of destination" has been thrown around a lot in terms of how to handle Internet taxation. Is that the direction you think taxation will go, and if so, how will this affect how these companies organize themselves and where they base themselves? Does relocating in one of these agile nations protect the e-commerce company from paying corporate taxes, or is it avoiding consumer taxes?
A: It's not clear what will prevail for determining nexus. There are almost as many criteria as taxing jurisdictions. You've got the location of the servers, the location of the company, the location of the company headquarters, the location of the company staff.... You've got where the data's stored, where the financial transaction occurs, where the settlement occurs, where the customer is, where the seller is, and where the goods are being warehoused and so on. I don't think there is any real clarity as to which one will start to emerge as the predominant determination of nexus.

As for basing [nexus] on destination, that worked fine when you were shipping containers of things. But as we move toward much more discrete transactions, where we're sending one widget to your and one widget to me, then it gets much more difficult to say where [a company is]. Is it where they are when they place the order? Is it where the order is being shipped to? When it's a matter of dealing with the shipping companies, it's possible to resolve this. But when you consider products being made available electronically--the music, movie, entertainment, content, information, publishing--the old model starts to break down a little bit.

Q: With companies having these dispersed structures, how is that going to affect criminal law from an international perspective? You've got pornography, intellectual property issues, identity theft, fraud. It gets even murkier than the taxation issue.
A: It gets extremely murky. There needs to be some kind of international body of law or code that prevails. So there is conversation now about just how the Uniform Commercial Code (UCC) worked very well as a broad commercial code that was then adapted a little bit locally. There's the potential to create some kind of GCC--a Global Commercial Code--that would provide a kind of umbrella of trust that defines what we as a global community consider to be fair and legitimate practices. Companies might agree voluntarily to comply with this code, and you can start tracking those who are in compliance. This is one long-term model that might emerge.

Q: How would this GCC be enforced?
A: The legal domain is becoming increasingly difficult to enforce. That's why I think the movement will be toward some kind of generally accepted code that people agree to comply with. There may be an economic incentive for people to step within this code. If you introduce the concept of bonding participants in this global community, those who comply with this code would have lower premiums. It's front-end incentive rather than a nebulous and unlikely back-end disincentive through the legal system. People are very adept at finding the legal system that suits them. That's why you've got all the gambling servers down there in Aruba and Antigua, and the pornography servers in the Netherlands. People are shopping for the jurisdiction that suits them best.

But I shouldn't give the impression that I'm only talking about the dark end of the economy, significant though it may be. It's also legitimate companies who want to grow their businesses with the minimum amount of regulation.

Q: How do you see this global commercial code being developed? Would you gather representatives from both sides together to draft it?
A: That would be the ideal way. We've had our own sort of stabs in that direction with specific initiatives in areas like public key infrastructures for security and so on. Being more realistic, I think what will happen will be that, just as Delaware jumped up and said 'We're a state and we can write our own laws, and we're going to write a set of laws that we think people are going to like,' what you're going to see is that a nation will catch onto this. There's an opportunity for one of these more agile nations to invest, gather half a dozen lawyers together and a few experts in e-commerce, and come with a body of law that is practical, equitable, and ajudicable. It will need a straight-forward arbitration process that can't be appealed, some kind of tax basis, and some kind of tax treaty with the other nations. This nation will pass this body into law, then encourage companies to do business in its jurisdiction. It'll be very attractive for corporations to register there, just as Delaware has 47 percent of the world's Fortune 500, these nations may find they're able to attract a similar percentage.

Q: Do you think there's going to be a trend toward greater regulation in countries like the U.S. and Great Britain?
A: Yes, I think there'll be attempts to increase that regulation. They're bringing out lots of additional statutes against money laundering, as they should.

Q: What would be the overriding philosophy that you would like to see G7 governments adopt toward e-commerce?
A: My personal stance--and this is only a personal opinion--would be that less is best. I'm fully supportive of the fact that we don't want to encourage money laundering. But there are ways to discourage it that are more effective [than regulation]. For example, creating incentives for conforming and establishing a sort of umbrella of trust under which that legitimate bodies can gather. And then there's a question mark hovering over everyone who's left outside that umbrella. The onus has to be transferred to [companies] to show that they're legitimate. Under the rather byzantine process we have right now where we have to go in and prove that someone is illegitimate. By the time we've done that, they've usually moved to another jurisdiction.

Q: You're thinking in terms of self-government?
A: Yes, that sounds almost naively idealistic. But that's what we have with the Internet right now. Look at the whole process with the IETF [Internet Engineering Task Force], and the way the Internet has evolved. The Internet is clearly not what it was four to five years ago. It's evolved, and they way that it's evolved is different. New protocols and standards are put up for comment, and people make their comments. There's a small group that sifts through those suggestions and comes up with a consensus. And then after a period of collecting comments, everyone's had a chance to have their say. This is legislation that happens in days, as opposed to years. This system has actually worked, very effectively, very quietly. You don't hear of much litigation over the structure of the Internet. The IETF and the Internet Society and a few noble luminaries in the field have been prepared at their own cost to provide their comments and to guide the general direction.

Q: Can this approach extend to business practices as well?
A: We're looking a little far forward obviously. This isn't a direction I would normally talk about in a traditional business forum. This is a long-term trend. But that would also go along with increased democritization of the political process, which will slowly become enabled through technology, since it's possible to have online voting, online referenda. All these things will be happening, but not overnight. Just as we do, most countries have entrenched political systems that benefit the incumbents and will be slow to change.

Q: So, you believe sluggish change and increased regulation will drive e-commerce companies to the smaller, more agile nations?
A: Free market forces will prevail. I think G7 nations will have to find a way to streamline and enable business rather than getting in the way of business. The nature of governments is to tax, obviously. But the more enlightened ones are starting to see that, in this case, it might not be the right philosophy. So I think some are trying to encourage and support the development of e-commerce, while others will try to restrict it. What tack will they take? It will vary from nation to nation. But I think there will be sufficient ones saying, "This is a huge opportunity. What can we do to support it?"

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