Net profits: taxing the Internet

This month the Inland Revenue (IR) and Her Majesty's Customs & Excise (C&E) are due to release their guidance paper on how the UK government should tax ecommerce. Not an enviable task.

Internet taxation is one subject few governments have rushed to address - despite the fact it's costing them money. Publicly, the policymakers say they want to give ecommerce time to become established, but in reality few governments know how to approach the subject.

The UK has at least established some guiding principles - neutrality, certainty, effectiveness and efficiency - but buzzwords are not very useful for businesses which need to know where they stand.

There are two key challenges facing the government: VAT (value-added tax) on the consumer, and corporation tax for businesses.

According to Richard Baron, IR advisor and deputy head of the policy unit at the Institute of Directors, the 'permanent establishment' (PE) principle - the basis of corporation tax - could cause the greatest headache.

PE rests on the assumption that corporation tax should be paid in the country where a company has its main fixed establishment. But in the brave new world of ebusiness, how is residency established?

The most likely answer will be Web servers - find which country the servers are based in, and tax the company there.

But will this policy leave the UK fighting a tax war with its neighbours? Ireland is introducing a tax rate of 12.5 per cent from 2003 for the trading income of all companies, and dot-coms could find themselves being tempted away from the UK.

The government has already set itself the task of establishing the PE principle by March 2000 - an ambitious target that could cause a few sleepless nights.

It is essential that this month's guidance paper does more than repeat the buzzwords. Policy delays have already left the UK struggling to keep up with its European neighbours and the government can't afford to let countries like Ireland and Germany create attractive tax havens.

In the short term it may be painful to lose tax revenue, but if the UK can establish itself as a healthy ecommerce business environment, investment will come flooding in. Who knows - the revenue generated may even go up.