Most sectors of the traditional pre-internet business world have struggled to keep pace with the changes brought about by the globalised digital economy. The law is no exception – around the world legal institutions are trying to catch up, often driven by the immediate need to catch the proceeds of digital transactions in the taxman’s net.
In June 2018, in a case called South Dakota v Wayfarer Inc, the US Supreme Court delivered a landmark judgement, taking traditional concepts and reshaping them to address the digital economy. The immediate result is a major change in the taxing of online transactions. However, the implications go far beyond taxation.
The case itself was about the liability for sales tax in the state of South Dakota. Under US law, a business must have a “presence” in a state before the state can levy sales tax on sales to customers in the state. In the “old” days it was pretty obvious – a presence was established physically: by a shop, a warehouse, and administration office and the like.
Prior to the Wayfarer case, the US courts had held that an online purchase by a customer in one state, from a business based in another state, does not of itself establish a presence for that business in the customer’s state. Therefore, no sales tax is payable in the purchaser’s state.
That, of course is exactly the same kind of problem that the Australian government has been grappling with in relation to online purchases by Australian customers from overseas businesses.
In the Wayfarer case, the US Supreme Court held to the orthodox position that in order to tax transactions a state must demonstrate that the merchant has a “presence” in the state. However, the Court departed from the previous law by finding that the presence does not need to be physical – just as goods can be sold digitally, so also can the presence be established digitally, such as by the downloading of cookies onto a purchaser’s computer, or the installation of an app on a customer’s device. The presence having been established, the state can charge sales tax on online purchases by its residents from the merchant.
Why is this ruling significant?
In a narrow sense the Wayfarer decision applies to the levying of sales tax within the USA. However, it has a global significance, because it indicates a major shift in the thinking of judges, and the legal system, in the world’s largest economy, on how to deal with the rise of the digital economy.
The ruling sees the laws move beyond the traditional definition of a ‘physical presence’ (such as a bricks and mortar shop or headquarters) to one that embraces the new digital ecosystem of cookies, websites, apps and more.
Whilst the Supreme Court ruling only relates to US states, the issues are global, and it can be expected that the decision will have a similarly global impact. It is a manifestation of the general consensus and direction of the OECD and countries such as Australia who are currently grappling with how taxing rights can be asserted over digital transactions that have no physical presence.
Why does the law need to change?
Twenty years ago the internet scarcely existed, and there was no digital economy. Today it is worth approximately $3 trillion dollars.* As we all know, the internet has revolutionised the way we shop, and established itself as an entire ecosystem on its own.
Our system of law is based on a system of court decisions and precedents built over centuries – it is not easily equipped to deal with the magnitude of rapid change we have seen in the past twenty years. Even when Parliament makes laws, it tends to do so by reference to what has happened in the recent past, and even that has provided little guide to the near future.
In this particular instance, the traditional requirement for a ‘physical presence’ before the transaction could be taxed resulted in an unintentional ‘tax shelter’ for businesses that could limit their physical presence to one state or country, yet still sell their goods and services across many states or countries. In the Wayfarer case it was state sales tax at risk, but it applies equally to GST in Australia, and indeed to income tax on the businesses revenues in the relevant state or country.
As long as internet sales were an insignificant part of the mix, tax authorities, and the courts, were willing g to tolerate this anomaly – no more!
The tides are turning
The US Supreme Court’s decision is the one of the first, and certainly the most significant, judicial recognition of this reality, but it is simply the forefront of a rising tide of legal opinion.
Across the Atlantic, the European Commission has released a proposal to ensure that each EU member state amends its tax law to treat an entity that has a “significant digital presence” in the member state as having a taxable presence (“digital permanent establishment (PE)”.
In Australia, tax experts argued that the absence of GST on services and products imported by consumers represented an omission from the tax base that was increasingly untenable. Therefore in order to recoup this forgone GST revenue (which would be passed to the States and Territories) and create a more even playing fields for domestic businesses, as of 1st July 2017, the Government extended GST to offshore supplies to Australian consumers***.
Up until now the online behemoths such as Amazon, Google and Apple have quite legitimately used the system as they found it and have been able to book super-profits as a result. That system is now changing, and they will have to change with it.
Technology and innovation can get ahead of the law for a while, but given time, like the tortoise plodding after the hare, the law catches up.
If you would like to know more or need any assistance, feel free to contact us at Antcliffe Scott, we’d be more than happy to help!
Footnotes
*As at 2016.
https://www.forbes.com/sites/koshagada/2016/06/20/the-digital-economy-lets-follow-the-money/#6d3da1c478cb
**https://ec.europa.eu/taxation_customs/business/company-tax/fair-taxation-digital-economy_en
***https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/rp/BudgetReview201516/Digital#_ftn1