Taxation of Electronic Commerce: Federal Income Tax Issues in the Establishment of a Software Operation in a Tax Haven

Abstract

The advent of the Internet and other electronic means of conducting commercial transactions has created a new galaxy of ways to structure business operations and a concomitant range of novel tax issues. It is commonly said that, because of the diminished need for a vendor to have a physical presence in the country of the customer, one of the likely effects of electronic commerce will be to shift revenues away from source jurisdictions and towards residence jurisdictions. In fact, this may be only partially true. Income may be shifted away from the customers' countries all right, but into a tax haven jurisdiction rather than into the enterprise's home jurisdiction. A major issue for enterprises that use the Internet and their residence tax jurisdictions, therefore, will be whether controlled foreign corporation or similar legislation will operate to impose tax on any revenues that are shifted in this manner.
The purpose of this paper is to consider how a hypothetical business operation structured to operate in a tax haven might be treated under United States federal income tax law, both under provisions taxing income at the source and under provisions taxing U.S. persons on tax haven income of foreign corporations, and then to reflect on what, if anything, this tells us about the need for change. Because the Internal Revenue Service has issued a regulation discussed below, specifically characterizing income derived from transactions in computer software (and not other types of transactions in electronic commerce), the paper will focus on a company delivering software over the Internet; but many of the issues presented will arise in the case of other Internet providers.