Transforming the internet into a taxable forum: A case study in E-commerce taxation

Minnesota Law Review

Volumn 85, Issue 5, 2001, Pages 1171-1265

  Cockfield, Arthur J ^a,b  

^a Thomas Jefferson School of Law   (United States)

^b QUEEN S UNIVERSITY   (Canada)

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[No Author keywords available]

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EID: 0347018526     PISSN: 00265535     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (413)

1. Lev Grossman, Attack of the Love Bug, TIME, May 15, 2000, at 48, 50-51. The Love Bug initially appeared as an e-mail with the subject line indicating "ILOVEYOU" and an attachment. Id. When recipients clicked twice on the attachment, software code was activated, which replaced computer files on the user's hard drive with copies of the Love Bug, hence acting like a computer virus. Id. The Love Bug then searched for the Microsoft Outlook Express e-mail program and sent copies of itself to everyone listed in the address book. Id. The fact that the Love Bug reproduced itself over the Internet resembles the work of a computer worm. Id. at 51.
2. Dawn Kawamoto, "Love" Bug Damages Businesses Most, at http://www.news.cnet.com/news/0-1003-200-1845293.html (May 9, 2000).
3. Grossman, supra note 1, at 50.
4. Id. at 50-51.
5. Id. at 50; see also Associated Press, The Damage of the "Love Bug," at http://www.theage.com.au/news/20000507/A45892-2000May6.html (May 7, 2000) (citing an estimate by Computer Economics Inc.).
6. See Grossman, supra note 1, at 53, 56. Jeff Carpenter of the CERT Coordination Center, a federally financed network security organization, warned, "Without architectural improvements [to the Internet,] we will see this again." Id. at 56.
7. LAWRENCE LESSIG, CODE AND OTHER LAWS OF CYBERSPACE 5-8 (1999) (arguing that government must regulate the architecture of the Internet to ensure it can ultimately impose regulations on Internet participants because, otherwise, commerce will construct this architecture in a way that could undermine state interests);
8. Lawrence Lessig, The Zones of Cyberspace, 48 STAN. L. REV. 1403, 1408 (1996) ("Law as code is a start to the perfect technology of justice."). Lessig speaks more broadly of other forces that can constrain an individual's behavior, including real law, the market, and norms. See id. at 1407-09. Code can be similarly used to modify behavior by making some actions harder (or impossible) to accomplish in cyberspace. Id. at 1407-08;
9. see also ANDREW L. SHAPIRO, THE CONTROL REVOLUTION 14-15 (1999);
10. Yochai Benkler, Overcoming Agoraphobia: Building the Commons of the Digitally Networked Environment, 11 HARV. J.L. & TECH. 287, 368 (1998) (discussing how the architecture of the Internet affects the distribution of control over content);
11. Joel R. Reidenberg, Lex Informatica: The Formulation of Information Policy Rules Through Technology, 76 TEX. L. REV. 553, 556-68 (1998) (suggesting policies to shape information flows).
12. LESSIG, supra note 7, at 6.
13. See generally M. Ethan Katsh, Software Worlds and the First Amendment: Virtual Doorkeepers in Cyberspace, 1996 U. CHI. LEGAL F. 335. Katsh indicates, To a considerable extent, networks really are what software allows them to be. The Internet is not a network but a set of communications protocols. . . . [T]he Internet is software. Similarly, the World Wide Web is not anything tangible. It is client-server software that permits machines linked to a network to share and work with information on any of the connected machines.
14. Id. at 341. The Internet, hence, is a "software world," id. at 339, where "code is the Law," id. at 340 (quoting WILLIAM J. MITCHELL, CITY OF BITS: SPACE, PLACE, AND THE INFOBAHN 111 (1995));
15. see also MARK STEFIK, INTERNET DREAMS: ARCHETYPES, MYTHS, AND METAPHORS 389-97 (1996) (discussing how great social tasks - like the construction of the Internet - can only be sustained through great social energy and wise choices);
16. Joel R. Reidenberg, Governing Networks and Rule-Making in Cyberspace, in BORDERS IN CYBERSPACE 84, 96 (Brian Kahin & Charles Nesson eds., 1997) ("Policy makers must begin to recognize network sovereignty and begin to shift the regulatory role of states toward indirect means that develop network rules.").
17. See ORGANIZATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT (OECD), THE ECONOMIC AND SOCIAL IMPACT OF ELECTRONIC COMMERCE: PRELIMINARY FINDINGS AND RESEARCH AGENDA 12 (1999) [hereinafter OECD ELECTRONIC COMMERCE REPORT]. The market for Internet sales from businesses to consumers was, according to one estimate, roughly $26 billion in 1997. Id. at 27. It is anticipated that business-to-business transactions, which in 1999 accounted for 80% of all e-commerce activity, will dominate e-commerce transactions at least in the short term. Id. at 36. Twelve separate studies forecasted total e-commerce revenues between $10 billion and $1.5 trillion in 2000-2002. Id. at 41. More recent studies predict higher revenues. For example, Forrester Research, Inc. estimates $2.7 trillion in revenue for the business-to-business market in the United States alone in 2004.
18. Press Release, Forrester Research, eMarketplaces Will Lead US Business eCommerce to $2.7 Trillion in 2004, at http://www.forrester.com/ER/Press/Release/ 0,1769,243,FF.html (Feb. 7, 2000).
19. For a general discussion of the international tax challenges presented by e-commerce, along with options available to tax authorities to meet these challenges, see generally Arthur J. Cockfield, Balancing National Interests in the Taxation of Electronic Commerce Business Profits, 74 TUL. L. REV. 133 (1999). This Article builds on the research and analysis from that previous paper.
20. For a discussion on the impact of e-commerce on state and local government tax revenues, see ADVISORY COMMISSION ON ELECTRONIC COMMERCE, REPORT TO CONGRESS 13-15, 17-18 (April 2000), available at http://www.ecommerce-commission.org [hereinafter ADVISORY COMMISSION REPORT]. It is generally thought that revenue losses are currently relatively small, although it is anticipated that losses will increase as e-commerce develops. The U.S. General Accounting Office (GAO) notes the difficulties in estimating sales tax losses and projects losses between $1 billion and $12.4 billion for the year 2003 if consumer Internet sales are not taxed.
21. GENERAL ACCOUNTING OFFICE, SALES TAXES: ELECTRONIC COMMERCE GROWTH PRESENTS CHALLENGES; REVENUE LOSSES ARE UNCERTAIN 20-21 (June 2000).
22. Another study estimates that in 1999, state governments collected $140 million in sales and use taxes from Internet retail purchases, but were unable to collect $525 million from additional Internet retail sales. Dick Kelsey, Forrester: Half Billion in Online Sales Taxes Uncollected, at http://www.findarticles. com/m0HDN/2000_Feb_24/59615701/pl/article.jhtml (Feb. 24, 2000).
23. Another study projected future revenue losses for 2003 to be $3.5 billion, which is less than 2% of all revenues to be collected from sales tax for 2003. Austan Goolsbee & Jonathan Zittrain, Evaluating the Costs and Benefits of Taxing Internet Commerce, 52 NAT'L TAX J. 413, 417 (1999).
24. More specifically, the case study examines a draft proposal by an e-commerce Working Party to the Organization for Economic Co-operation and Development (OECD), the leading international organization charged with developing tax rules to govern the taxation of cross-border e-commerce transactions, permitting countries to tax businesses that employ computer servers within their countries. See OECD, WORKING PARTY NO. 1 ON TAX CONVENTIONS AND RELATED QUESTIONS, CLARIFICATION ON THE APPLICATION OF THE PERMANENT ESTABLISHMENT DEFINITION IN E-COMMERCE: CHANGES TO THE COMMENTARY ON ARTICLE 5 (Dec. 22, 2000), available at http://www.oecd.org/daf/fa/material/mat_07.htm#material_final [hereinafter OECD PROPOSAL]. In March 2000 and October 1999, the OECD Working Party released earlier drafts of the proposal, which are also available at the same website.
25. Most international organizations and governments have insisted on preserving traditional international tax principles for the taxation of e-commerce. See JOINT DECLARATION OF BUSINESS AND GOVERNMENT REPRESENTATIVES: GOVERNMENT/BUSINESS DIALOGUE ON TAXATION AND ELECTRONIC COMMERCE OECD MINISTERIAL CONFERENCE 1 (Oct. 7, 1998), available at http://www.oecd.org/daf/fa/e_com/Ottawa.htm [hereinafter JOINT GOVERNMENT/BUSINESS REPORT] ("The taxation framework for electronic commerce should be guided by the same taxation principles that guide governments in relation to conventional commerce.");
26. see also generally AUSTRALIAN TAX OFFICE, TAX AND THE INTERNET: DISCUSSION REPORT OF THE ATO ELECTRONIC COMMERCE PROJECT (1997), http://www.ato.au/indexlist. asp?placement=AS/TS+k=internet+d=internet+1=1 [hereinafter AUSTRALIAN REPORT];
27. OECD, ELECTRONIC COMMERCE: THE CHALLENGES TO TAX AUTHORITIES AND TAXPAYERS (1997), http://www.oecd.org/daf/fa/e_com/ turku.htm [hereinafter OECD TURKU REPORT];
28. OECD, COMMITTEE ON FISCAL AFFAIRS, ELECTRONIC COMMERCE: TAXATION FRAMEWORK CONDITIONS 4 (1998), available at http://www.oecd.org/daf/fa/e_com/Ottawa.htm [hereinafter OECD TAXATION FRAMEWORK];
29. INLAND REVENUE & HM CUSTOMS AND EXCISE, ELECTRONIC COMMERCE: UK TAXATION POLICY ¶ 10 (1998), at http://213.38.88.195/coi/coipress.nsf;
30. MINISTER'S ADVISORY COMMITTEE ON ELECTRIC COMMERCE, ELECTRONIC COMMERCE AND CANADA'S TAX ADMINISTRATION: A REPORT TO THE MINISTER OF NATIONAL REVENUE FROM THE MINISTER'S ADVISORY COMMITTEE ON ELECTRONIC COMMERCE ¶ 2.4.3.3 (1998), at http://www.ccra-adrc.gc.ca/tax/business/ecomm/ecom0-e.html [hereinafter CANADIAN REPORT];
31. A European Initiative in Electronic Commerce, COM(97)157 ¶ 56 (1997), at http://www.cordis.lu/esprit/src/ecomcomx.htm;
32. President William J. Clinton & Vice President Albert Gore, Jr., A Framework for Global Electronic Commerce § I.1 (1997), http://www.iitf.doc.gov/eleccomm/ ecomm.htm.
33. Federal lawmakers have banned any discriminatory taxes on the Internet, which effectively prevents the development of regulations that could protect state and local sales tax bases. See Internet Tax Freedom Act, Pub. L. No. 105-277, § 1101, 112 Stat. 2681, 2719-21 (1998) (creating a moratorium on discriminatory taxes on the Internet that will expire October 21, 2001); see also Internet Nondiscrimination Act of 2000, H.R. 3709, 106th Cong. (2000) (approved by the House of Representatives on May 10, 2000). This legislation extends the Internet Tax Freedom Act moratorium by five years. See generally Doug Sheppard, House Approves Internet Tax Moratorium Extension, 87 TAX NOTES 874 (2000). Certain Republican lawmakers oppose any Internet taxation as espoused in a recent "e-Contract 2000" that pledges to "continue legislative and oversight efforts to remove the barriers to future innovation, competition, and growth."
34. Heidi Glenn, GOP Outlines Antitaxation E-commerce Agenda, 87 TAX NOTES 875, 875 (2000) (quoting House Majority Leader Richard K. Armey, R-Texas).
35. In the absence of a tax treaty, the residence country generally grants a foreign tax credit to the resident taxpayer for foreign taxes paid, or exempts from taxation all foreign profits in order to alleviate any international double taxation. See, e.g., I.R.C. § 901 (West 2000); 26 C.F.R. § 1.901-2 (1991). The requirement of a permanent establishment in source countries is analogous to the U.S. constitutional requirement that permits U.S. states to impose and collect state and local sales taxes only if those businesses maintain a substantial physical presence within the state. As a result, there is a question whether computer servers located within a state will constitute this requisite physical presence. See, e.g., Michael Folz Wexler, Internet Tax Freedom Acts, 38 CAL. TAX LAW. 11, 13 (Spring 1999) ("Some states have asserted that the hosting - or even the transitory presence - of the seller's website on a computer server in the customer's state suffices for jurisdiction.").
36. If a permanent establishment does not exist, the source country may still be entitled to impose a withholding tax on the gross amount of the payment for the e-commerce good or service if the transaction gives rise to certain types of income, such as royalties or interest. Tax treaties generally reduce the withholding tax for these types of income. For example, the United States generally imposes a rate of 30% on most passive investment income. I.R.C. § 881(a)(1) (1994). The United States Model Treaty, however, suggests much lower rates, such as 5% for most dividends, and no withholding tax on interest and royalties. United States Model Income Tax Convention, Sept. 20, 1996, arts. 10-12, 1 Tax Treaties (CCH) (Warren, Gorham, & Lamont eds., 1996) [hereinafter U.S. Model Treaty].
37. See, e.g., U.S. Model Treaty, supra note 17, art. 5(2);
38. OECD, Committee on Fiscal Affairs, Model Tax Convention on Income and on Capital, art. 5 (1997) [hereinafter OECD Model Tax Treaty].
39. See, e.g., U.S. Model Treaty, supra note 17, art. 5(5);
40. OECD Model Tax Treaty, supra note 18, art. 5(5).
41. For a more thorough discussion of permanent establishment issues, see generally ARVID A. SKAAR, PERMANENT ESTABLISHMENT: EROSION OF A TAX TREATY PRINCIPLE (1991).
42. For a historical overview of these developments, see JOHN HUSTON & LEE WILLIAMS, PERMANENT ESTABLISHMENTS: A PLANNING PRIMER 1-10 (1993); SKAAR, supra note 20, at 65-101; Cockfield, supra note 11, at 135-36, 144-48;
43. Michael J. Graetz & Michael M. O'Hear, The "Original Intent" of U.S. International Taxation, 46 DUKE L.J. 1021, 1022-89 (1997).
44. International businesses were concerned that they could be doubly taxed on their cross-border transfers. For example, a shoe manufacturer based in the United States (the residence country) may want to sell its shoes to consumers in France (the source country), for a total profit on the sale often dollars per pair. Both the United States and France may assert tax jurisdiction over the profits, resulting in double taxation of the same business transaction. The International Chamber of Commerce, founded in 1919, and the 1920 International Financial Conference in Brussels, both appealed to the League of Nations to provide guidance to eliminate double taxation. SKAAR, supra note 20, at 78-79. The League formed a committee of four economists to study the issue of double taxation in 1922. See id.
45. For a recent discussion of international tax principles, see generally Nancy H. Kaufman, Fairness and the Taxation of International Income, 29 LAW & POL'Y INT'L BUS. 145 (1998).
46. For views supporting the need to preserve source state taxation of e-commerce profits, see Charles E. McLure, Jr., Taxation of Electronic Commerce: Economic Objectives, Technological Constraints, and Tax Laws, 52 TAX L. REV. 269, 361-62 (1997);
47. David R. Tillinghast, The Impact of the Internet on the Taxation of International Transactions, 50 INT'L BUREAU FOR FISCAL DOCUMENTATION BULL. 524, 525 (1996).
48. Commentators have proposed rules that could expand source state tax jurisdiction for e-commerce. See, e.g., Reuven S. Avi-Yonah, International Taxation of Electronic Commerce, 52 TAX L. REV. 507, 532-41 (1997) (proposing a destination-based system to tax e-commerce profits);
49. Richard L. Doernberg, Electronic Commerce and International Tax Sharing, 16 TAX NOTES INT'L 1013, 1016-17 (1998) (suggesting that an e-commerce business-to-business withholding tax may be appropriate).
50. In fact, many developing nations have opposed the permanent establishment principle since its inception. In 1940, a subcommittee to the League of Nations was charged with reviewing the model bilateral tax treaty that was initially put in place in 1928. See SKAAR, supra note 20, at 88-95. Interestingly, the majority of these subcommittee members were representatives from Latin American countries that were not active in the early years of World War II. Id. These representatives drafted source-based provisions that were favorable to the interests of their countries, which were generally net capital importers at the time. Id. For example, source countries were permitted to tax business profits within their borders as long as the transactions that gave rise to these profits were not isolated. Id. The existence of a permanent establishment was not required. Id. The draft treaty, known as the Mexico 1943 Draft, was never adopted, and a subsequent draft in London in 1946 required that a foreign business entity have a permanent establishment in the source country before its profits would be subject to any income taxes imposed by the source country. Id.
51. See MP3.com homepage, at http://mp3.com (last visited Jan. 31, 2001).
52. MP3.COM, CORPORATE OVERVIEW, at http://www.mp3.com/investor (last visited Jan. 31, 2001). In addition to its database of music, MP3.com provides a number of services for its customers that enables them to access, manage, and listen to their own music collections in a number of different ways.
53. See MP3.COM, INC., 1999 ANNUAL REPORT 1 (2000), available at MP3.com homepage, supra note 25 [hereinafter MP3.COM ANNUAL REPORT].
54. MP3.COM ANNUAL REPORT, supra note 26, at 14.
55. Id. The servers are hosted at facilities in San Diego, Sunnyvale, and Irvine. Id.
56. Telephone Interview with Steven M. Przesmicki, Vice President, Legal Affairs, MP3.com, Inc. (July 18, 2000).
57. In fact, MP3.com is moving to a subscription-based business model where consumers pay a monthly fee in order to gain access to the MP3.com database of music stored in MP3 format. See MP3.com homepage, supra note 25. The new subscription fees were announced as part of MPS.com's settlement with the Recording Institute of America, which had sued MP3.com for copyright violation. See infra text accompanying note 114.
58. See supra note 10.
59. The international e-commerce business-to-consumer market is less important because it represents less than 20% of overall revenues, has so far generated few profits, and consumers in many markets still lack access to the Internet. See, e.g., OECD ELECTRONIC COMMERCE REPORT, supra note 10, at 34-36.
60. See generally Arthur J. Cockfield, Electronic Commerce, Developing Countries and Declining Tax Revenues, UNESCO ENCYCLOPEDIA OF LIFE SUPPORT SYSTEMS (forthcoming) (draft on file with author).
61. This discussion ignores to a large extent how businesses are harnessing Internet technologies to improve profitability and productivity. In fact, the largest productivity gains for businesses employing Internet technologies have thus far surrounded improving efficiency all along the value-added chain, from the supply of raw materials, to sales, to the end consumer. Corporations employ extranets that link up their own businesses with suppliers, distributors, and other business partners creating so-called "fully integrated value chains." For example, suppliers can now track customer demands through an extranet and ensure their products arrive at the appropriate moment - a process improving on existing "just-in-time" inventory management techniques. This will permit companies to remove support personnel in source countries and to save on expenses by lowering their inventory carrying costs.
62. For a recent discussion on emerging business models, such as reverse auctions and aggregators, see KARL FRIEDAN, CYBERTAXATION 35-39 (1999) (discussing the trends toward remote selling and global trading).
63. Auto dealers report productivity gains from their websites. See OECD ELECTRONIC COMMERCE REPORT, supra note 10, at 60. These companies spend only twenty-five dollars to deal with an e-commerce generated bid instead of several hundred dollars to deal with traditional face-to-face transactions because customers come "pre-qualified." Id.
64. For an introduction to this topic, see generally Andrew L. Shapiro, Digital Middlemen and the Architecture of Electronic Commerce, 24 OHIO N.U. L. REV. 795 (1998).
65. See Amazon.com homepage, at http://www.amazon.com/exec/obidos/ subst/home/home.html (last visited Mar. 8, 2001).
66. See E*trade homepage, at http://www.etrade.com/cgi-bin/gx.cgi/ AppLogic+Home (last visited Mar. 8, 2001).
67. A research study estimates that it costs roughly $500 to $700 to send a service representative into the field, $15 to $20 to handle a customer question over the telephone, and only about $7 to set up and maintain an Internet-based customer service system. OECD ELECTRONIC COMMERCE REPORT, supra note 10, at 61.
68. Further, websites permit multinational businesses to gather information on foreign markets without a local office. A multinational company's website can perform a number of administrative tasks that previously required employees or fixed bases within source countries. Websites can perform administrative functions such as communicating with the head office when a sale is registered within the source country, automatically taking into consideration exchange rates, and crediting an accounts receivable account to the head office's accounting software program.
69. See Ariba.com homepage, at http://www.ariba.com (last visited Mar. 8, 2001).
70. Some of these new intermediaries are independent companies, such as VerticalNet, which create markets to link buyers with sellers. Alternatively, a consortium of companies can try to set up their own virtual marketplace. Ford, General Motors, and DaimlerChrysler recently announced the creation of a virtual marketplace for the purchase and sale of an estimated $240 billion worth of parts and supplies. Seller Beware, THE ECONOMIST, Mar. 4, 2000, at 61.
71. For example, a U.S. manufacturing company that makes drill bits may currently maintain a sales and marketing office in Argentina, which is used to sell and distribute products to various businesses in the Latin American market. These Latin American business customers will soon be hooked into the U.S. company's extranet and can order products without consulting the Argentine sales office. These latter sales will not be taxed by Argentina or any other Latin American country because they do not emanate from a permanent establishment within Latin America.
72. A source country will be able to tax the home base activities if the source country has negotiated a "restricted force of attraction" clause within its tax treaty network because the existing permanent establishment "attracts" certain profits emanating from the home base. For example, if a U.S.-based multinational company transfers e-commerce goods or services from its home office to a foreign market where it maintains a traditional permanent establishment that sells similar goods or services, a restricted force of attraction rule will permit the source country to tax profits from home office sales as well as profits that are attributable to the permanent establishment. See United Nations Model Double Taxation Convention Between Developed and Developing Countries, Jan. 1, 1980, art. 7(1), 1 Tax Treaties (CCH) (Warren, Gorham, & Lamont eds., 1996) [hereinafter United Nations Model Tax Treaty]. Most industrialized countries, such as the United States, have been reluctant to negotiate such a provision. Of course, the restricted force of attraction rule will be of little use if the U.S. drill bit manufacturer closes down its Argentine office and exclusively sells its goods via the Internet.
73. See supra text accompanying note 19.
74. For example, Cisco Systems estimates that 55% of its orders are accomplished through the company's websites, at an estimated savings of $500 million a year. Cisco@speed, Survey: Business and the Internet, THE ECONOMIST, June 26, 1999, at 12.
75. Unlike a dependent agent, an independent agent is not an employee of the multinational firm nor would the independent agent fall under the daily control of the firm. Independent agents include commissioned agents and brokers and generally would act on behalf of several different clients. For a discussion on the distinction between independent and dependent agency status, see generally Handfield v. Comm'r, 23 T.C. 633 (1955).
76. The United Nations Model Tax Treaty contains a provision that permits source countries to tax the profits associated with independent agents in certain circumstances, but capital exporting countries have generally been reluctant to agree to this provision within their tax treaty network. See United Nations Model Tax Treaty, supra note 45, arts. 5(6)-(7).
77. Independent contractors do not constitute permanent establishments under the U.S.-India Tax Treaty. Income Tax Treaty, Dec. 18, 1990, U.S.-India, art. 5(5), 2 Tax Treatises (CCH) (Warren, Gorham, & Lamont eds., 1996). This article further indicates, "When the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm's-length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph." Id. Even if the software engineer is not considered to be an independent agent, he does not fulfill the functions of a dependent agent that give rise to a permanent establishment, such as the habitual conclusion of contracts within the source country.
78. SEE U.S. DEPARTMENT OF THE TREASURY, OFFICE OF TAX POLICY, SELECTED TAX POLICY IMPLICATIONS OF GLOBAL ELECTRONIC COMMERCE ¶ 9 (1996), available at http://www.fedworld.gov/pub/tel/internet.txt [hereinafter TREASURY REPORT].
79. See id. ("Certain issues may initially appear to be so complex that they cannot be dealt with by existing principles. Further study is likely to result in the conclusion that one or more existing principles are more flexible than they may seem and they remain relevant notwithstanding technological developments.").
80. JOINT GOVERNMENT/BUSINESS REPORT, supra note 14, at 1.
81. See OECD TAXATION FRAMEWORK, supra note 14, ¶ 4 ("The taxation principles which guide governments in relation to conventional commerce should also guide them in relation to electronic commerce. The [Committee on Fiscal Affairs] believes that at this stage of development in the technological and commercial environment, existing taxation rules can implement these principles."). The Committee makes it clear that new measures are permissible as long as they assist in the application of existing taxation principles and do not impose a discriminatory tax on e-commerce. Id. ¶ 5.
82. See, e.g., AUSTRALIAN REPORT, supra note 14, ¶ 7.2.15 ("A web site located on a server, that is fixed in time and location, and through which business is carried on may constitute a [permanent establishment]."); HERB DHALIWAL, ELECTRONIC COMMERCE AND CANADA'S TAX ADMINISTRATION, A RESPONSE BY THE MINISTER OF NATIONAL REVENUE TO His ADVISORY COMMITTEE'S REPORT ON ELECTRONIC COMMERCE ¶ 6.3.2.4 (1998), available at http://www.ccra-adrc.gc.ca/tax/business/ecomm/index-e.html ("Whether a file server fits the definition of a [permanent establishment] will depend on the facts and circumstances of the particular case. This issue will be dealt with on a case-by-case basis in a manner that is consistent with the Department's current published interpretations and rulings.");
83. Dow Famulak et al., Taxation of Electronic Commerce: Asia-Pacific, 20 TAX NOTES INT'L 877, 884 (2000) (discussing permanent establishment issues in Asia).
84. But see Friedrich E.F. Hey, German Tax Authorities Rule That Server Does Not Constitute PE, 19 TAX NOTES INT'L 635, 635 (1999) (noting that German tax authorities indicate that "for the time being" a server will not be considered a permanent establishment under the definition in the OECD model tax treaty because the activities associated with the server are preparatory in nature);
85. Press Release, Inland Revenue, Electronic Commerce: Tax Status of Web Sites and Servers (April 11, 2000), available at http://www.inlandrevenue.gov.uk/e-commerce/ ecom15.htm (indicating that servers will not constitute a permanent establishment for U.K. tax purposes).
86. See AUSTRALIAN TAXATION OFFICE, TAX AND THE INTERNET: SECOND REPORT ¶¶ 5.3.47-5.3.72 (1999), available at http://www.ato.gov.au/content. asp?doc=/content/Businesses/ecommerce_tati2.htm [hereinafter SECOND AUSTRALIAN REPORT] (querying whether the permanent concept is fair in the e-commerce arena if use of this concept punishes capital importing nations).
87. Tax treaty negotiation takes place between government representatives of the tax authorities from the two states and not diplomats as would normally occur in the negotiation of an international agreement. If one side requests a new tax benefit for its residents, the other side will often ask for some other tax concession for its own residents.
88. OECD PROPOSAL, supra note 13, ¶ 1.
89. Chuck Gnaedinger, OECD Tax Body Agrees on Concept of Permanent Establishment for E-Commerce, 22 TAX NOTES INT'L 227, 227 (2001).
90. OECD PROPOSAL, supra note 13, ¶ 42.2. Spain and Portugal, however, took the position that a website in and of itself may constitute a permanent establishment in the context of e-commerce. Id. ¶ 6. The OECD Proposal notes that its mandate was not to address broader issues involving whether the permanent establishment concept is appropriate for e-commerce; these issues are being scrutinized by an OECD Technical Advisory Group on Monitoring the Application of Existing Norms for the Taxation of Business Profits. See id. ¶ 4.
91. Id. ¶ 42.2.
92. Id. ¶ 42.4.
93. Id. ¶ 42.8.
94. Id. ¶ 42.9.
95. Id. ¶ 15.
96. Id. ¶ 42.6. Earlier drafts of the proposal set out different views concerning whether the human intervention must take place in the source country or from a remote location, whether the intervention needs to be that of an employee or some other person, and the extent of the human intervention required (in other words, maintaining the server verses operating the server).
97. Id. ¶ 42.3. The proposal notes that ISPs will generally not act as dependent agents with authority to conclude contracts on behalf of their principals (and thus deemed to be permanent establishments). Id. ¶ 42.10.
98. Id. ¶ 42.7.
99. See id.
100. OECD Model Tax Treaty, supra note 18, art. 5(4).
101. OECD PROPOSAL, supra note 13, ¶ 42.7.
102. See OECD Model Tax Treaty, supra note 18, cmt. art. 5, ¶ 10. The commentary further indicates that if vending machines are initially set up and then leased, a permanent establishment will not exist. Id. A permanent establishment may exist if the company that owns the machines operates and maintains the machines for its own account or hires a dependent agent to do so. Id.
103. But see HUSTON & WILLIAMS, supra note 21, at 45 (suggesting that the notion that the vending machines themselves could be considered to be permanent establishments is inconsistent with other authority in the area).
104. See, e.g., U.S. Model Treaty, supra note 17, art. 17(1) (permitting source countries to tax artists and athletes whose gross income within the source country exceeds $20,000). The theory behind the fictions is that the athletes or artists derive substantial compensation from the opportunities presented by the source country's markets and hence the source country should enjoy the resulting tax revenues despite the temporary nature of the activities. Similar arguments could be extended to e-commerce activities that generate significant revenues within source countries as a result of the temporary presence of websites or, arguably, the functions associated with the computer programs within servers.
105. See TREASURY REPORT, supra note 51, ¶ 7.2.3.1;
106. OECD TURKU REPORT, supra note 14, ¶ 100.
107. See SECOND AUSTRALIAN REPORT, supra note 56, ¶ 5.3.31 (noting that "[t]he physical location of a website or server is becoming increasingly irrelevant as bandwidth and response time problems are being overcome," leading to problematic tax planning opportunities).
108. For an accessible and comprehensive technical description of servers, see TOM SHELDON, THE WINDOWS NT WEB SERVER HANDBOOK 8-37 (1996).
109. See id. at 119-51 (describing software functions within a server).
110. See id. at 12.
111. A recent trend involves peer-to-peer networking where users do not have to resort to any centralized server. Users can access directories over a centralized server, but can then trade digital products among each others' personal computers. For a discussion of this industry trend, see Jerome Kuptz, The Peer-to-Peer Network Explosion, WIRED, Oct. 2000, at 234.
112. See generally Arthur J. Cockfield, Compliance Strategies for U.S. Companies with International E-commerce Transactions, in 4 PRACTICAL U.S. INT'L, TAX STRATEGIES 8, 1, 5 (2000).
113. Industrialized countries generally do not maintain tax treaties with tax havens, thus a tax treaty interpretation of a "permanent establishment" will not be an issue. If a company is initially incorporated in a tax haven, or anywhere, it will generally be considered to be a resident of that country. Alternatively, servers that perform active business functions in tax havens may escape anti-avoidance tax rules that generally impose current taxation on passive activities.
114. Sports International, the largest online gambling company, is located in Grenada. OECD ELECTRONIC COMMERCE REPORT, supra note 10, at 39.
115. A significant amount of online pornography operations apparently take place within Guyana. Cybersex: An Adult Affair, THE ECONOMIST, Jan. 4, 1997, at 64.
116. For example, Bermuda, a tax haven, is reportedly marketing itself as an e-commerce center for businesses. See Globalization and Tax, THE ECONOMIST, Jan. 29, 2000, at 16. Even countries that are not tax havens have an incentive to compete for highly mobile e-commerce businesses by offering preferential tax breaks to these companies.
117. See, e.g., Linda Ng, Singapore Offers Tax Incentives and Advantages to E-Businesses, 21 TAX NOTES INT'L 1, 16 (2000).
118. See Simson Garfinkel, Welcome to Sealand. Now Bugger Off, WIRED, July 2000, at 230.
119. See id. at 235.
120. See Cockfield, supra note 11, at 148-50, 188-91.
121. It should also be noted that the more ambitious taxpayers can simply incorporate a company in a tax haven even if servers are not considered to give rise to permanent establishments under tax treaties. The Treasury Department has noted that existing controlled foreign corporation (CFC) rules may not cover the activities associated with many e-commerce operations. See TREASURY REPORT, supra note 51, ¶¶ 7.3.4-7.3.5. This seems to be a particularly astute observation. For example, U.S. tax rules mandate accrual taxation, current taxation whether or not profits are repatriated to the United States, of CFCs that generate certain types of passive income. See I.R.C. §§ 951-64 (West 2000). There is an exception, however, if the CFC manufactures goods. See 26 C.F.R. § 1.954-3(a)(4) (1983). Would the creation of a digital product within the server constitute "manufacturing"?
122. According to an earlier OECD report, hosting should not create a permanent establishment within the source country. See OECD, WORKING PARTY NO. 1 ON TAX CONVENTIONS AND RELATED QUESTIONS, PROPOSED CLARIFICATION OF THE COMMENTARY ON ARTICLE 5 OF THE OECD MODEL CONVENTION, REVISED DRAFT FOR COMMENTS ¶ 3 (Mar. 3, 2000), available at http://www.oecd.org/daf/fa/material/mat_07.htm#material_mardh [hereinafter OECD DRAFT].
123. For a discussion of industry trends in hosting agreements and the legal implications of such an agreement, see generally Matthew M. Neumeier et al., eCommerce "Storefront" Development & Hosting, in ECOMMERCE: STRATEGIES FOR SUCCESS IN THE DIGITAL ECONOMY 375, 375-451 (1999).
124. A smaller e-commerce business can purchase one server to perform multiple functions such as mail, web applications, and data storage, all within one box. For example, Cobalt Networks sells a Cobalt Qube that combines a number of different applications into one box, partly to ease a network administrator's job. See Cobalt Networks homepage, at http://www.cobalt.com/index. html (last visited Mar. 8, 2001). A larger e-commerce business may need to use hundreds of servers within its server architecture with each server performing a unique function and possibly even involving different platforms such as Windows NT or Linux.
125. AUSTRALIAN REPORT, supra note 14, ¶ 7.5.4.
126. It should be noted that the line between hardware and software functions is sometimes unclear. For example, servers often employ both hardware firewalls (a separate box with network security software loaded into it) and software firewalls to promote network security. Cisco Systems - traditionally a hardware manufacturer and distributor - has begun to sell many of its servers with monitoring and firewall software pre-loaded into the server. See Cisco Systems homepage, at http://www.cisco.com (last visited Mar. 8, 2001).
127. Under most tax treaties, source countries are only permitted to tax profits attributable to permanent establishments within their countries. In its March 3, 2000 draft report on the topic, the OECD Working Party acknowledged the concern surrounding the difficulties associated with allocating profits to a server, but indicated, "It seems inappropriate to suggest that if attribution proves to be difficult, one should go back and decide there is no permanent establishment." OECD DRAFT, supra note 89, ¶ 14. Moreover, it was noted that the attribution issue should fall within the mandate of the Technical Advisory Group on Monitoring the Application of Existing Treaty Norms for the Taxation of Business Profits. Id. ¶ 16.
128. Carol A. Dunahoo, E-Commerce Tax Study Group Responds to OECD Request, 2000 WORLDWIDE TAX DAILY 11-18.
129. For a discussion of tax compliance problems associated with income characterization issues, permanent establishment issues, and record-keeping obligations, see generally Arthur Cockfield, Tax Compliance Issues for U.S. Companies with International Electronic Commerce Transactions, 20 TAX NOTES INT'L 223 (2000).
130. U.S. tax rules impose foreign tax credit limitations to ensure that U.S. resident taxpayers cannot receive a credit that reduces their tax liabilities arising from sources within the United States. See I.R.C. § 904(a) (West 2000). Take the example of the transmission of a digital music file from a U.S.-based resident through a server located in France. France may tax the profits attributable to the server under the proposed OECD approach, but the United States may still characterize the transaction as generating only U.S. source income if the digital product is considered to be inventory in the United States when titled passed. See I.R.C. § 861(a)(6) (West 2000). If the sales agreement specifies that title to the inventory passes in France, the U.S. resident may be able to claim a foreign tax credit for income attributable to "sales activity" under the 50/50 method. See 26 C.F.R. § 1.863-3(b)(1)(i) (1998). For many digital products, however, the vendor will retain at least some rights to the product and the transaction arguably gives rise to royalty income with a different set of source rules. Recent changes to Treasury regulations suggest a substance-over-form test for transfers of software programs, but it is unclear whether these rules should apply to transfers of e-commerce products. See 26 C.F.R. § 1.861-18 (1998).
131. MP3.com, along with other e-commerce companies, has expressed concerns surrounding costs associated with complying with the tax laws of foreign jurisdictions. See MP3.COM ANNUAL REPORT, supra note 26, at 17 ("In addition, foreign jurisdictions may seek to impose tax collection obligations on companies like us that engage in online commerce. If they do, these obligations could limit the growth of electronic commerce internationally and limit our ability to profit from the sale of goods and services over the Internet in foreign countries.").
132. The production of e-commerce goods or services often involves high fixed costs but low marginal costs for replicating the good or service. Consider the development of an online auction like eBay. See eBay homepage, at http://www.ebay.com (last visited Mar. 8, 2001).
133. The initial development of the software to run the auction could take years, but once the service is up and running, the service may require far lower expenditures to maintain or expand for additional users. For a discussion of information economics, see generally CARL SHAPIRO & HAL R. VARIAN, INFORMATION RULES (1999).
134. This position is somewhat ironic because the U.S. government funded and created the Internet in the first place. See, e.g., Steve Bickerstaff, Shackles on the Giant: How the Federal Government Created Microsoft, Personal Computers, and the Internet, 78 TEX. L. REV. 1, 45-55 (1999) (discussing how the infrastructure of the Internet remains subsidized by taxpayers through telecommunications laws).
135. President William J. Clinton, Presidential Directive on Electronic Commerce, at http://www.ecommerce.gov/presiden.htm (last modified Dec. 17, 1997).
136. See supra note 15.
137. See supra note 15.
138. See Sheppard, supra note 15, at 877 (indicating that insiders feel the Senate "is where the real battle will be"); Declan McCullagh, Capitol Hill Divided on Net Tax, WIRED NEWS, at http://www.wired.com/news/politics/ 0,1283,36154,00.html (May 6, 2000) (noting that some Republicans in Congress worry about blame from state officials if revenue from sales taxes declines).
139. See Quill Corp. v. North Dakota, 504 U.S. 298, 308, 317-18 (1992) (involving a use tax that the state sought to impose when companies established a connection by advertising periodically within the state). In this case, the Court stated that the commerce clause prohibits the imposition by states of laws that could have a discriminatory impact on interstate commerce and therefore the requirement of a physical presence within the state prior to taxation is not unreasonable. Id. The Court noted, however, that the due process doctrine would not require any physical presence requirement and that Congress could pass laws to eliminate any commerce clause limitation. Id.
140. See, e.g., ADVISORY COMMISSION REPORT, supra note 12, at 14-15 (noting a study that indicates states are "generally in good to excellent fiscal condition").
141. The anti-tax sentiment is exemplified by the passage in the House of Representatives of the Tax Code Termination Act, which sought to eliminate the income tax code by December 31, 2002. See Tax Code Termination Act, H.R. 3097, 105th Cong. (1998). For an accessible review of proposals to move toward flat taxes and other consumption taxes, see generally JOEL SLEMROD & JON BAKIJA, TAXING OURSELVES: A CITIZEN'S GUIDE TO THE GREAT DEBATE OVER TAX REFORM (2d ed. 2000).
142. See generally David R. Johnson & David Post, Law and Borders - The Rise of Law in Cyberspace, 48 STAN. L. REV. 1367 (1996) [hereinafter Johnson & Post, Law and Borders];
143. David R. Johnson & David G. Post, The Rise of Law on the Global Network, in BORDERS IN CYBERSPACE, supra note 9, at 3 [hereinafter Johnson/Post BORDERS];
144. David R. Johnson & David G. Post, The New "Civic Virtue" of the Internet: A Complex Systems Model for the Governance of Cyberspace (1998), available at http://www.temple.edu/lawschool/dpost/ Newcivicvirtue.html;
145. David G. Post & David R. Johnson, The New Civic Virtue of the Net: Lessons from Models of Complex Systems for the Governance of Cyberspace (working paper draft, 1997), at http://stlr.stanford.edu/STLR/ Working_Papers (last visited Feb. 20, 2001);
146. David G. Post, Anarchy, State, and the Internet: An Essay on Law-Making in Cyberspace (1996), at http://www.temple.edu/lawschool/dpost/Anarchy.html.
147. For a similar perspective, see generally Llewellyn Joseph Gibbons, No Regulation, Government Regulation, or Self-Regulation: Social Enforcement or Social Contracting for Governance in Cyberspace, 6 CORNELL J.L. & PUB. POL'Y 475 (1997).
148. Johnson & Post, Law and Borders, supra note 107, at 1370-76. Johnson and Post argue that if governments impose legal jurisdiction over activities associated with websites that appear on the computers of their residents, all web-based activity must necessarily be subjected to simultaneous laws of all territorial governments. Id. at 1376-77.
149. For example, if Germany prohibits the transmission from German-based servers of pornography, then German web users can simply access the same information emanating from a server based in some other country. In addition, Johnson and Post assert that it simply is not practical to monitor the volume of electronic communications crossing territorial borders. Johnson/Post BORDERS, supra note 107, at 3, 8;
150. see also A. Michael Froomkin, The Internet as a Source of Regulatory Arbitrage, in BORDERS IN CYBERSPACE, supra note 9, at 129, 129-32.
151. Johnson & Post, Law and Borders, supra note 107, at 1379.
152. Id. at 1387. "We believe the Net can develop its own effective legal institutions." Johnson/Post BORDERS, supra note 107, at 3, 21.
153. For a discussion of recent developments with respect to these self-regulatory bodies, see Regulating the Internet: The Consensus Machine, THE ECONOMIST, June 10, 2000, at 73. The article notes the difference between W3C, which is largely self-governing and ICANN, which is generally self-governing but permits governments to have input through a governmental advisory committee. Id. at 79.
154. See TREASURY REPORT, supra note 51, ¶¶ 6.3.1-6.3.6. The Treasury notes that the Internet is radically decentralized (where users have no control over the path taken by their transmissions); disintermediated (removing from the transaction chain important intermediaries such as financial institutions which act as taxing points); anonymous (making it difficult to determine an individual's location); and intangible (noting that a personal letter is indistinguishable from a message transmitting electronic money). Id.
155. See generally UMG Recordings, Inc. v. MP3.Com, Inc., 92 F. Supp. 2d 349 (S.D.N.Y. 2000), cert. denied, 2000 WL 710056 (S.D.N.Y. June 1, 2000); A&M Records, Inc., v. Napster, Inc., 114 F. Supp. 2d 896 (N.D. Cal. 2000), aff'd in part, rev'd in part, 239 F.3d 1004 (9th Cir. 2001). The RIAA can enforce copyright laws against both of these companies because both maintain central servers that process either digital goods or information required by users of the service. MP3.com maintains a centralized database of digitized music, which is accessed by users. Napster, on the other hand, does not maintain a centralized database of music, although it does maintain servers that provide a directory of available songs to users. For commentary, see Napster and the Damage Done, THE ECONOMIST, July 29, 2000, at 33 (explaining Napster's software and discussing RIAA's actions in trying to prevent customers from using the service or otherwise exchanging songs over the Internet).
156. See MP3.com homepage, supra note 25.
157. See Napster homepage, at http://www.napster.com (last visited Mar. 8, 2001).
158. Most exchanges over the Internet currently involve a "client," typically an individual's personal computer, and a "server," typically a more powerful computer that has been networked to the Internet. In a distributed information network, all computers act as both clients and servers. Gnutella users search the hard drives of other Gnutella users to locate available songs. The only way an organization such as the RIAA could enforce copyright laws against Gnutella users would be to obtain an injunction against each individual user. See Here, There and Everywhere, THE ECONOMIST, June 24, 2000, at 91;
159. see also Michelle Delio, Why Music Trading Won't Die, WIRED NEWS, at http://www.wired.com/news/culture/0,1284,37831,00.html (July 27, 2000) (explaining that programs such as Gnutella center around music files "set free" onto open servers, making it "nearly impossible for anyone to stop anyone else" from downloading the files).
160. For a comprehensive account of these possible technologies, see MARK STEFIK, THE INTERNET EDGE: SOCIAL, TECHNICAL AND LEGAL CHALLENGES FOR A NETWORKED WORLD 55-106 (1999);
161. see also Peter H. Lewis, Napster: Why the Web is All Shook Up, SAN DIEGO UNION-TRIBUNE, July 11, 2000, at ComputerLink p. 6.
162. Under the Johnson-Post model, the OECD Working Party's efforts would be criticized because these efforts would (1) create inconsistent or conflicting rules when applied by tax authorities, (2) suffer from a lack of notice of the rules to Internet participants, and (3) overly burden these participants who would have to comply with the rules by allocating profits to their foreign servers.
163. See supra notes 107-12 and accompanying text.
164. See, e.g., LEO STRAUSS, NATURAL RIGHT AND HISTORY 35-80 (1953). Strauss discusses the views of Max Weber, perhaps the greatest social scientist of the century. For Weber, the role of social science is to present facts and their causes in an ethically neutral way without commenting on questions of value. See id. Weber insisted [that] the social scientist does not evaluate the objects constituted by "references to values"; he merely explains them by tracing them to their causes . . . . Weber contended that his notion of a "value-free" or ethically neutral social science is fully justified by what he regarded as the most fundamental of all oppositions, namely, the opposition of the Is and the Ought, or the opposition of reality and norm or value. Id. at 40-41. Strauss, however, offers a more nuanced view of the argument by asserting that social science "is meant to be of practical value. It tries to find means for given ends. For this purpose it has to understand the ends." Id. at 41. Strauss, like Weber, recognizes that there is not any one true value system that can be accessed by reason, but asserts that the role of social science or social philosophy is to mediate and clarify the conflict between alternative value systems and reveal the implications of each system on human conditions. Id. Because evolution has proceeded in certain particular way, it does not follow that course is morally right or desirable. The justification of ethical norms on biological evolution, or on any other natural process, can only be achieved by introducing value judgments, human choices that prefer one rather than other object of process. Biological nature is in itself morally neutral.
165. F.J. Ayala, The Biological Roots of Morality, 2 BIOLOGY & PHILOSOPHY 235, 245 (1987).
166. Communication over the Internet can be broken down into three general forms: (1) individual free speech communication, (2) individual commercial communication, and (3) machine-to-machine communication. Raymond Ku and I examine the regulatory implications of each category along with the difficulties associated with regulating overlapping categories. See Arthur Cockfield & Raymond Ku, So What's the Big Deal About the Internet? Musings on the Great Link (forthcoming) (manuscript at 12-16, on file with author). Johnson and Post note that cyberspace is not homogenous, but made up of distinct subsidiary "territories" with distinct regulatory needs that defy traditional forms of regulation.
167. See Johnson/Post BORDERS, supra note 107, at 3, 13-15; see also Reidenberg, supra note 9, at 87.
168. For an account of these different forms of communication, see LESSIG, supra note 7, at 63-83.
169. See, e.g., Viktor Mayer-Schonberger & Teree E. Foster, A Regulatory Web: Free Speech and the Global Information Infrastructure, in BORDERS IN CYBERSPACE, supra note 9, at 235, 246-47 ("[N]ational regulators must recognize that domestic controls and enforcement are futile regulatory mechanisms for an international structure in which information can be redeployed and disseminated in a matter of seconds."). For a recent review of First Amendment principles and the Internet,
170. see generally Raymond Shih Ray Ku, Open Internet Access and Freedom of Speech: A First Amendment Catch-22, 75 TUL. L. REV. 87 (2000).
171. See sources cited supra note 124.
172. See, e.g., Henry H. Perritt, Jr., Cyberspace Self-Government: Town Hall Democracy or Rediscovered Royalism?, 12 BERKELEY TECH. L.J. 413, 419 (1997) (advocating that self-regulation is generally desirable for individual communities on the Internet).
173. Johnson and Post recognize, however, that the decision to regulate becomes less troublesome the more one strays from a pure cyberspace experience. See Johnson & Post, Law and Borders, supra note 107, at 1401. For example, an Internet transaction that involved money changing hands in the "real" world might call for real world regulations. See id. 128. For an account of possible directions and implications of the continuing evolution of the Internet, see generally STEFIK, supra note 118. While Stefik believes the Internet is only beginning to demonstrate its potential as a commercial medium, he additionally believes the Internet will act as a forum to explore the diversities and similarities of the human race. Id. at 290. Stefik concludes, When we see the many different faces of each other, may we recognize them as the faces of our selves. In this way the Net as a change amplifier and the Net as a portal into cyberspace and the Net as a knowledge medium can also be an agent that moves us further into the mystery of life and deeper into an understanding of who we are. Id. The challenge for regulators will be to accomplish their agenda by regulating commerce while permitting the less commercial aspects of the Internet to develop. It will probably be many years before a satisfactory equilibrium is reached that reconciles the tension between the need to protect state interests and the desire to encourage human flourishing on the Internet.
174. See, e.g., SHAPIRO, supra note 7, at 31. Shapiro notes, [I] t would be a mistake, conceptually and practically, to erect a barrier between online and offline activity. Cyberspace is not somewhere "out there," a world apart from flesh and blood, asphalt and trees. Our actions online have (need it be said?) a real impact on the lives of other human beings. When a fraudulent securities offering on the Net cause novice investors to be bilked of their hard-earned money, for example, that's a "real world" injury. Id.
175. The current absence of taxation on many Internet transactions acts as a form of subsidy if traditional transactions remain taxed. High technology companies have lobbied hard to maintain the current regime for obvious reasons: taxes will ultimately lower their after-tax returns and may even require a reevaluation of the arguably over-priced share valuations that many e-commerce companies continue to enjoy. Lower share values will reduce the value of stock option compensation that forms a significant component of the total compensation package for many high technology employees. Further, lower share values will make it more difficult for these companies to access equity capital for expansion purposes or to simply keep the companies afloat. A couple of caveats should be noted. First, most start-up Internet companies remain unprofitable at this point and therefore do not have to pay income taxes. Second, under the semi-strong version of the Capital Market Hypotheses, the market should have already priced the shares accurately by taking into account all publicly available information, including the probability of new legislation that would impose taxes on Internet transactions.
176. I am not going as far as some who suggest that cyberlaw is indistinguishable from traditional law. See, e.g., Frank H. Easterbrook, Cyberspace and the Law of the Horse, 1996 U. CHI. LEGAL F. 207, 210.
177. For a response to this position, see Lawrence Lessig, The Law of the Horse: What Cyberlaw Might Teach, 113 HARV. L. REV. 501, 502 (1999) (arguing that cyberlaw teaches, among other things, the limits and potential of law as a regulator of this new forum for communication and commerce).
178. See Johnson/Post BORDERS, supra note 107, at 3, 22-24.
179. From a normative perspective, even a non-efficient regulatory outcome may be acceptable if the regulations protect values. For a general discussion on the advantages and limitations of self-regulation on the Internet, see generally Monroe E. Price & Stefaan G. Verhulst, In Search of the Self: Charting the Course of Self-Regulation on the Internet in a Global Environment (forthcoming) (draft on file with author).
180. See, e.g., Margaret Jane Radin & R. Polk Wagner, The Myth of Private Ordering: Rediscovering Legal Realism in Cyberspace, 73 CHI.-KENT L. REV. 1295, 1295-96 (1998) (arguing that Internet private ordering depends on statecreated rules governing contract and property, as do all forms of private ordering). In a recent work, Professor Barbara Fried traces the origins of the Legal Realist movement in its earlier stages, noting that an important agenda of the Realists was "to debunk the notion of a freestanding, self-regulating market, by showing that the market was ineluctably constituted by the legal regime in which it operated."
181. BARBARA H. FRIED, THE PROGRESSIVE ASSAULT ON LAISSEZ FAIRE: ROBERT HALE AND THE FIRST LAW AND ECONOMICS MOVEMENT 13 (1998).
182. DAN SCHILLER, DIGITAL CAPITALISM 87 (1999). Schiller suggests that we are in danger of permitting industry to determine critical public interests such as education or communications policy. See id. at 205. For the first time since its emergence in the early twentieth century, the corporate-led market system no longer confronts a significant socialist adversary anywhere on the planet. Digital capitalism also is free to physically transcend territorial boundaries and, more important, to take economic advantage of the sudden absence of geopolitical constraints on its development. Id.
183. Bill Daley, Address at the OECD Ministerial Conference on E-Commerce, Ottawa (Oct. 7-9, 1998) (asserting that U.S. companies will develop appropriate information collection policies that are aligned with the privacy needs of their customers).
184. For a review of U.S. policy, see UNITED STATES, PRIVACY AND ELECTRONIC COMMERCE (June 1998), available at http://www.doc.gov/ecommerce/privacy.html. The policy was not intended to apply in all circumstances and Congress has passed legislation to control privacy practices of websites that collect information on children. See Children's Online Privacy Protection Act of 1998, 15 U.S.C. §§ 6501-6506 (Supp. 2000).
185. For a review of general privacy issues, see generally Paul M. Schwartz, Privacy and Democracy in Cyberspace, 52 VAND. L. REV. 1609 (1999).
186. See FEDERAL TRADE COMMISSION, ONLINE PROFILING: A REPORT TO CONGRESS 3-5 (June 2000), available at http://www.ftc.gov/os/2000/06/ onlineprofiling-reportjune2000.pdf [hereinafter ONLINE PROFILING].
187. Id. at 2-3. Cookies will remember user names and passwords and can be used to enable targeted news stories or personalized services such as stock portfolio tracking.
188. See FEDERAL TRADE COMMISSION, PRIVACY ONLINE: A REPORT TO CONGRESS iii (1998), available at http://www.ftc.gov/reports/privacy3/priv-23a. pdf.
189. See supra note 136 and accompanying text.
190. See Council of the European Union, Directive on the Protection of Individuals with Regard to the Processing of Personal Data and to the Free Movement of Such Data, 12003/1/95 REV 1 (adopted Feb. 1995), available at http://www.privacy.org/pi/int/_orgs/ec/final_EU_Data_Protection.html [hereinafter Privacy Directive].
191. For extensive analysis on the Privacy Directive and its potential impact on international data transmissions, see generally PETER R. SWIRE & ROBERT E. LITAN, NONE OF YOUR BUSINESS: WORLD DATA FLOWS, ELECTRONIC COMMERCE, AND THE EUROPEAN PRIVACY DIRECTIVE (1998).
192. See Privacy Directive, supra note 142, art. 7(a). The directive also requires all businesses to tell consumers how the information will be used. Id. art. 10(b).
193. The Privacy Directive indicates that personal data could be transferred to another country only if this country offers adequate privacy protection (presumably similar in nature to the EU's mechanisms for protecting personal privacy). See id. art. 25. On March 14, 2000, the United States and the European Commission reached a tentative agreement under so-called "safe harbor" principles (for example, notice, choice, and security) that will permit the transfer of personal data from the European Union to the United States. Brian W. Smith & Wendy L. Morris, A Closer Look at the "Safe Harbor" Principles in the U.S.-EU Agreement on Personal Data Transfers, 2 GLOBAL ECOMMERCE L. & Bus. REP. 6, 6-10 (2000).
194. See TRUSTe homepage, at www.truste.org (last visited Feb. 27, 2001) (noting that TRUSTe is funded by an industry consortium);
195. see also Better Business Bureau homepage, at http://www.bbbonline.org/consumers (last visited Feb. 10, 2001) (noting that its mission is to promote trust and confidence on the Internet by encouraging sound and ethical online business practices and by providing information to ensure better educated online consumers);
196. CPA WebTrust homepage, at http://www.cpawebtrust.org (last visited Feb. 27, 2001) (noting that its program involves a specially licensed Certified Public Accountant that examines a company's website to ensure that its web transactions meet the program's accepted high standards in areas including information protection, business practices, and transaction integrity).
197. See, e.g., Anonymizer.com homepage, at http://www.anonymizer. com/splash.shtml (last visited Feb. 10, 2001);
198. Zero Knowledge homepage, at http://www.zeroknowledge.com (last visited Feb. 10, 2001). San Diego-based Anonymizer.com permits Internet users to surf the web on an anonymous basis.
199. See Anonymizer.com homepage, supra. Anoymity, however, is only granted to the user while Anonymizer.com itself, through its proxy server, is aware of websites visited by the user (and promises not to give out this information, absent a warrant). See id. Accordingly, regulators could focus on Anonymizer.com if they wish to regulate this area. Montreal-based Zero Knowledge recently launched a more effective technology to mask a user's identity on the Internet; the identity is masked by a cloud of servers that prevent even Zero Knowledge from tracking the user. See Zero Knowledge homepage, supra. It may not be possible to regulate this type of masking technology. Zero Knowledge has provided, online, several papers that discuss its technology. See Freedom.net homepage, at http://www.freedom.net/info/ whitepapers/index.html (last visited Feb. 10, 2001).
200. See, e.g., Enonymous.com homepage, at http://www.enonymous.com (last visited Mar. 8, 2001);
201. P3P homepage, at http://www.w3.org (last visited Mar. 8, 2001). Enonymous.com has rated over 30,000 websites for their privacy practices and attaches this information to a browser companion. See Enomymous.com homepage, supra. Web surfers can choose to enter a website after they view the privacy rating. P3P has posted the following description at its website: The Platform for Privacy Preferences Project (P3P), developed by the World Wide Web Consortium, is emerging as an industry standard providing a simple, automated way for users to gain more control over the use of personal information on Web sites they visit. At its most basic level, P3P is a standardized set of multiple-choice questions, covering all the major aspects of a Web site's privacy policies. P3P homepage, supra. One of the main differences between the approaches developed by these two companies is that Enonymous.com does not require commercial websites to participate with its efforts to identify privacy practices, whereas P3P needs commercial websites to employ its technology so that the web surfer does not have to "click" on a prompt to proceed into the website. At the time of this writing, only a few companies had decided to participate in the P3P project.
202. See, e.g., ONLINE PROFILING, supra note 138, at 11 (noting a recent FTC study that indicates many companies fail to accurately disclose their privacy policies in their websites). [A]lthough 57% of a random sample of the busiest Web sites allowed third parties to place cookies, only 22% of those sites mentioned third-party cookies or data collection in their privacy policies; of the top 100 sites on the Web, 78% allowed third-party cookie placement, but only 51% of those sites disclosed that fact. Id.
203. See DoubleClick homepage, at http://www.doubleclick.com (last visited Mar. 8, 2001).
204. See Tom McNichol, Double Agents, WIRED, June 2000, at 124 (comparing the practices of Russia's FSB, the intelligence agency descended from the KGB, to DoubleClick).
205. See RealNetworks homepage, at http://www.realnetworks.com (last visited Mar. 8, 2001). RealNetworks was collecting personal information on the listening habits of its customers in contravention of its privacy policy.
206. Sara Robinson, RealNetworks to Stop Collecting User Data, N.Y. TIMES ABSTRACTS, Nov. 2, 1999, available at 1999 WL 30547798.
207. The Federal Trade Commission prevented bankrupt Toysmart.com from selling its database of customer information after having assured hundreds of thousands of visitors to its website that personal data would never be shared with a third party. Matt Richtel, FTC Sues Toysmart.com to Halt Sale of Customer Database, SAN DIEGO UNION-TRIBUNE, July 11, 2000, at C3, available at 2000 WL 13975028;
208. see also Chris Oakes, Lack of Notice Snags E-Service, WIRED NEWS, Aug. 2, 2000, available at http://www.wired.com/news/ business/0,1367,37949,00.html (discussing how a number of commercial websites, including Toysrus.com and Lucy.com were giving their customers' personal information to an e-marketing company called Coremetrics).
209. Jacob J. Lew, director of the Office of Management and Budget, issued a memorandum the day after the controversy surrounding the government "cookies" was revealed that called for a review of government website privacy policies. John Schwartz, Federal Web Sites Get Privacy Check, WASHINGTON POST, June 23, 2000, at E2.
210. But see Associated Press, Drug Czar Seeks to Resume Office's Use of Net 'Cookies,' SAN DIEGO UNION-TRIBUNE, July 12, 2000, at A2 (describing efforts by Barry McCaffrey to turn his office's cookie machine back on);
211. Chris Oakes, Judge to FBI: Move on Carnivore, WIRED NEWS, Aug. 2, 2000, available at http://www.wired.com/news/politics/0,1283,37967,00.html (discussing how the Electronic Privacy Information Center sued the FBI, alleging that the FBI should be forced to disclose its illegal information gathering through the use of its Carnivore email surveillance system).
212. See ONLINE PROFILING, supra note 138, at 14 (discussing a 1999 IBM poll that suggests 92% of Internet users are concerned about threats to their personal privacy when they use the Internet while 72% say they are very concerned);
213. Jim Nesbitt, Keeping It Confidential, SAN DIEGO UNION-TRIBUNE, May 30, 2000, at Computerlink p.6, available at 2000 WL 13967615 (citing a U.S. Department of Commerce survey that indicates 86% of those who contemplate online shopping worry about giving away too much private information). Thirty states have apparently proposed some form of Internet privacy protection. Id.
214. See generally DEPARTMENT OF COMMERCE, NATIONAL TELECOMMUNICATIONS AND INFORMATION ADMINISTRATION, PRIVACY AND THE NII: SAFEGUARDING TELECOMMUNICATIONS-RELATED PERSONAL INFORMATION (1995), available at http://www.ntia.doc.gov/ntiahome/ privwhitepaper.html (discussing concerns surrounding the fact that many individuals may not be using the Internet due to privacy fears). But see SWIRE & LITAN, supra note 142, at 85-88 (noting increased privacy protections for consumers may increase business-to-consumer e-commerce, but data protection regulations will inhibit the more important business-to-business e-commerce by restricting data flows).
215. See generally Jennifer L. Alvey, Daley: Consumer Fears About Online Privacy, Individual Profiling Threaten E-Commerce, 4 ELECTRONIC COM. L. REP. 1040 (1999).
216. See FEDERAL TRADE COMMISSION, ONLINE PROFILING: A REPORT TO CONGRESS PART 2 (July 2000), available at http://www.ftc.gov/os/2000/07/ onlineprofiling.htm [hereinafter ONLINE PROFILING PART 2]. The report was issued by the Network Advertising Initiative (NAI). See id. pt. II.C. The report indicates that web users should be able to "opt in" to certain types of information gathering such as linking previously collected clickstream data to personalized information. See id. pt. II.D.2.
217. See id. pt. III. Nonetheless, backstop legislation addressing online profiling is still required to fully ensure that consumers' privacy is protected online. For while NAI's current membership constitutes over 90% of the network advertising industry in terms of revenue and ads served, only legislation can compel the remaining 10% of the industry to comply with fair information practice principles. Self-regulation cannot address recalcitrant and bad actors, new entrants to the market, and drop-outs from the self-regulatory program. Id. The FTC had proposed similar backstop legislation in its earlier report to Congress. See generally ONLINE PROFILING, supra note 138. The lone dissenting member indicated that he could not accept any such legislation because industry was already developing technologies to protect consumer privacy interests and legislation could inhibit the development of these new technologies.
218. See ONLINE PROFILING PART 2, supra note 157, attach.
219. See, e.g., Neil Weinstock Netanel, Cyberspace Self-Governance: A Skeptical View from Liberal Democratic Theory, 88 CAL. L. REV. 395, 476 (2000) ("Industry self-regulation, a group's regulation of its members' practices with the goal of reducing harmful externalities to outsiders, is notoriously inadequate to its task.").
220. See, e.g., ONLINE PROFILING PART 2, supra note 157, pt. II.B ("Unless the Web sites visited by consumers provide notice of the ad network's presence and data collection, consumers may be totally unaware that their activities online are being monitored."). For a discussion of possible market failures that could justify government intervention, see SWIRE & LITAN, supra note 142, at 7-9. The difference between off-line and online data tracking is that online consumers generally do not know that online companies are gathering data about them. See Netanel, supra note 159, at 476-77.
221. The counter argument is that Internet consumers accept intrusive snooping, but only at a price. The going "price" today is the availability of many free goods and services offered by commercial websites. These businesses can arguably offer to give away these services for "free" (of course, the goods or services are rarely truly free because the businesses sell data collected by website visitors) because they are indirectly generating revenues through either selling the collected personal data or permitting advertisers to employ personalized banner ads targeting website visitors.
222. Johnson/Post BORDERS, supra note 107, at 3, 10 ("Nor can legitimacy of any rules governing online activities be naturally traced to a geographically situated polity. There is no geographically localized set of constituents with a stronger claim to regulate it than any other local group; the strongest claim to control comes from the participants themselves, and they could be anywhere.").
223. This view can be represented by an oft-cited and colorful passage from John Perry Barlow, a prominent Internet commentator and ex-song writer for the Grateful Dead: Governments of the Industrial World, you weary giants of flesh and steel, I come from Cyberspace, the new home of Mind. On behalf of the future, I ask you of the past to leave us alone. You are not welcome among us. You have no sovereignty where we gather . . . . You have no moral right to rule us nor do you possess any methods of enforcement we have true reason to fear. Governments derive their just powers from the consent of the governed. You have neither solicited nor received ours. John Perry Barlow, A Declaration of the Independence of Cyberspace (1996), at http://www.eff.org/barlow.
224. Professor Netanel has extensively criticized the view that cyberspace can more fully realize liberal democratic ideals than does a nation state. See Netanel, supra note 159, at 410-46. Netanel argues that an absence of Internet regulation by democratic governments will ultimately result in disastrous results for many unempowered groups whose interests would be ignored by powerful groups who would control the Internet's regulatory agenda. Id. at 421-22. Netanel discusses the digital divide, which occurs as a result of uneven access to cyberspace, pointing out surveys that show U.S. households using the Internet "are overwhelmingly white, educated, and affluent." Id. at 445. He also notes how the spread of broadband technologies to a more affluent market may one day result in the offering of high quality content and technology to one group while another (less educated and less wealthy) group will only have access to the less efficient network. Id. Hence, governments should selectively regulate the Internet to protect the interests of individuals who would otherwise be left out of consideration. Id. at 498.
225. For a review of different possible approaches to tax international e-commerce profits, see Cockfield, supra note 11, at 167-85.
226. Jack L. Goldsmith, Against Cyberanarchy, 65 U. CHI. L. REV. 1199, 1199 (1998) (arguing that traditional tools of jurisdiction apply to Internet transactions).
227. For a criticism of the Johnson-Post model with respect to its inability to account for the costs of certain externalities, see Mark A. Lemley, The Law and Economics of Internet Norms, 73 CHI. L. REV. 1257, 1278 (1998) (using the example of copyright to argue that it is insufficient to permit Netizens to be governed by Internet norms).
228. See OECD ELECTRONIC COMMERCE REPORT, supra note 10, at 29.
229. See TREASURY REPORT, supra note 51, ¶ 7.1.5. The growth of new communications technologies and electronic commerce will likely require that principles of residence-based taxation assume even greater importance. In the world of cyberspace, it is often difficult, if not impossible, to apply traditional source concepts to link an item of income with a specific geographical location. Therefore, source based taxation could lose its rationale and be rendered obsolete by electronic commerce. By contrast, almost all taxpayers are resident somewhere. . . . United States tax policy has already recognized that as traditional source principles lose their significance, residence-based taxation can step in and take their place. This trend will be accelerated by developments in electronic commerce where principles of residence-based taxation will also play a major role. Id.
230. Residence-based taxation also suffers from the fact that this system would distort the market for traditional commercial activities (which would be subject to source state taxation when a permanent establishment exists) and e-commerce activities (which would never be subject to source state taxation). Market distortions would result because the after-tax cost of engaging in one activity or another may be different, despite the fact that the transactions may be economically identical. For example, the sale of a physical book through regular international commerce would be subject to source state taxation if the bookseller maintained a permanent establishment in the source country. The sale of a digital book would not be taxed by the source country under a residence-based tax system for e-commerce. For further discussion of this matter, see Cockfield, supra note 11, at 169-72.
231. I have proposed elsewhere that servers should not constitute permanent establishments but that rules are needed to allocate revenues to source countries where significant e-commerce activity takes place. See id. at 186-91. I consider a low e-commerce withholding tax on the gross payment for e-commerce goods and services above a certain threshold of sales, such as $1 million. See id. In addition, I discuss other mechanisms to expand a source country's tax base, such as a more widespread deployment of restricted force of attraction provisions that will permit source countries to attract profits from so-called "clicks and mortars" that rely on physical facilities and online services to deliver goods. See id. The business-to-business e-commerce withholding tax will be fairly straight-forward to administer although source countries would need to develop mechanisms to enforce the business-to-consumer withholding tax. See id. These source countries are unlikely to forego the potential revenues from business-to-consumer sales despite the compliance problems. For a discussion of the recent efforts by the European Union to characterize downloads of digitized goods and services as the supply of services in order to facilitate VAT enforcement against online retailers, see Council of the European Union, Directive on Electronic Commerce, 14263/1/99 REV 1 (ratified May 3, 2000).
232. Professor Netanel criticizes the view that cyberspace self-governance will promote liberal democratic values: Finally, cyberians [who promote Internet self-governance] give insufficient weight to the distributive function of liberal government. Liberal ideals can be realized only if the incidents of citizenship are distributed among all citizens. Yet opportunities to communicate, process information, and even gain access to cyberspace are vastly unequal. The cyberian vision lacks a vehicle to provide such citizenship resources to those who currently lack them. Without state intervention, therefore, cyberspace self-governance will, at best, resemble the Athenian democracy of the privileged few, not participatory liberalism. Netanel, supra note 159, at 406.
233. Johnson and Post note, however, that self-regulation by Internet participants is subject to limitation when it oversteps its appropriate sphere. See Johnson/Post BORDERS, supra note 107, at 3, 34.
234. AMERICAN BAR ASSOCIATION, ACHIEVING LEGAL AND BUSINESS ORDER IN CYBERSPACE: A REPORT ON GLOBAL JURISDICTION ISSUES CREATED BY THE INTERNET, LONDON MEETING DRAFT 162 (2000), available at http://www.kentlaw.edu/cyberlaw/documents.html [hereinafter ABA LONDON DRAFT].
235. See OECD TAXATION FRAMEWORK, supra note 14, ¶ 9.
236. The OECD does note, however, that the neutrality principle ensures that the Internet should not be treated as a tax-free environment. See OECD, COMMITTEE ON FISCAL AFFAIRS, IMPLEMENTING THE OTTAWA TAXATION FRAMEWORK CONDITIONS 2 (2000). The solution will have to involve a broad multilateral effort because of the nature of e-commerce, the world's first truly borderless form of international commerce. In the absence of any kind of world tax authority, the OECD continues to be the appropriate forum to arrive at the multilateral solution. The OECD has suggested that any new rules should "achieve a fair sharing of the tax base" from e-commerce, but has yet to elaborate on what is meant by "fair."
237. OECD TAXATION FRAMEWORK, supra note 14, ¶ 6.
238. Even tax havens use payroll taxes and indirect taxes to raise revenues. These tax havens generally do not impose income taxes.
239. David L. Lupi-Sher, The U.S. IRS's Fight Against Abusive Offshore Trusts, 21 TAX NOTES INT'L 176, 177 (2000). One of the more interesting debates taking place within financial circles is whether the development of e-cash and Internet banking will mean the end to central banks that control interest rates by acting as the monopoly suppliers of different types of currency. If e-cash replaces physical cash, then central bankers will not have the leverage to control the money supply. Professor Goodhart notes, however, that physical cash is truly anonymous (and therefore desirable) whereas e-cash relies on the trustworthiness of Internet banks to preserve anonymity.
240. Charles Goodhart, Can Central Banking Survive the IT Revolution? (July 2000), at http://www.worldbank.org/research/interest/confs/upcoming/papersjuly11/good hart.pdf. Hence, real cash will not go away any time soon. Goodhart further suggests that central banks may one day control interest rates by borrowing or lending e-cash at amounts that are different than prevailing interest rates. Id.
241. For a call to preserve the ability of U.S. states to impose sales taxes on incoming e-commerce sales despite the absence of a substantial physical presence, see generally Walter Hellerstein, State Taxation of Electronic Commerce, 52 TAX L. REV. 425 (1997).
242. See supra text accompanying notes 24-25.
243. See supra text accompanying notes 23-24.
244. See supra text accompanying notes 32-33.
245. See infra text accompanying notes 225-26, 315-19.
246. See, e.g., Roger H. Gordon & Joosung Jun, Taxes and the Form of Ownership of Foreign Corporate Equity, in STUDIES IN INTERNATIONAL TAXATION 13, 13-14 (Alberto Giovannini et al. eds., 1993).
247. Governments and international organizations have tended to focus on the impact of taxes on international portfolio investments due to greater mobility of production and the existence of concrete empirical data that suggests taxes greatly influence portfolio investment decisionmaking. See generally Joosung Jun, U.S. Tax Policy and Direct Investment Abroad, in TAXATION IN THE GLOBAL ECONOMY 55 (Assaf Razin & Joel Slemrod eds., 1990). The extent by which taxes influence FDI movements is hotly debated by economists because FDI placement is influenced by a number of factors such as political stability or lower labor costs. Id. at 58. Still, economists generally assert that FDI movements are influenced by tax incentives (or disincentives) although many dispute the relative importance of taxes in comparison to these other factors. See id.
248. The United States and Argentina have not negotiated a tax treaty. As a result, domestic U.S. law will govern the tax treatment of this portfolio investment. Portfolio interest received by a nonresident person is exempt from U.S. taxes. I.R.C. § 871(h) (1994). In addition, other forms of passive income received by nonresidents are generally not taxed. For example, interest earned on deposits with any U.S. bank or financial institution is exempt from U.S. tax when the interest is paid to a foreign person. I.R.C. § 871(i) (1994).
249. For example, U.S. law taxes its residents and citizens on all income "from whatever source derived." I.R.C. §§ 1, 61(a) (1994).
250. The United States and Argentina have not negotiated a tax treaty that would provide for an exchange of information. In fact, Salvatore would probably be better off to initially use a tax haven as an intermediary to conduct his investment in the United States in order to avoid the possibility of the U.S. tax authorities notifying the Argentine government of the investment. The U.S. tax authorities generally cannot ascertain with any accuracy the identity of investors who invest through holding companies located in tax havens because most tax havens have bank secrecy laws that prohibit giving out any confidential client information such as the identity of the individuals who own the shares in the holding company.
251. For a discussion of the impact of capital flight on revenue losses, see Reuven S. Avi-Yonah, Globalization, Tax Competition, and the Fiscal Crisis of the Welfare State, 113 HARV. L. REV. 1573, 1599 (2000).
252. See Jeffrey Owens Discusses Details of OECD Harmful Tax Practices Report, 21 TAX NOTES INT'L 94, 95 (July 10, 2000). Further, government officials may be concerned that bank secrecy laws in tax havens, combined with the non-reporting of transactions involving U.S. residents, may lead to billions of dollars leaving the United States for offshore havens. See S. REP. No. 99-130, at 139-41 (1985) [hereinafter SENATE COMMITTEE REPORT] ("Criminal activity in the United States is unquestionably aided by the use of foreign jurisdictions to divert enormous amounts of illegal profits from the United States. Clearly, billions of U.S. dollars derived from illegal activities are being funnelled offshore."). Under U.S. tax law, illegal income is subject to taxation. I.R.C. §§ 1, 61(a) (1994).
253. Avi-Yonah, supra note 189, at 1584.
254. For example, under the withholding option, a bank would withhold $20 (20%) when it paid a foreign investor $100 in interest. The bank then remits this amount to the federal government and the foreign investor can get a credit from his own government for taxes paid on the interest income (assuming the investor reports the income to his own government). Under the exchange of information option, the bank (or tax authority) simply notifies the country where the beneficial owner of the interest is located of the interest payment. The home country can then assess its own tax on the payment.
255. See Commission Proposal for a Council Directive to Ensure a Minimum of Effective Taxation of Savings Income in the Form of Internet Payments Within the Community, art. 2(1), 1998 O.J. (C212) 13, 15.
256. Id. art.7.
257. Id. art. 8. The withholding tax must be credited against the any tax liability in the investor's home country or refunded if the withholding tax exceeds the home country tax liability. Id. art. 10.
258. Id. art. 8.
259. See Joann Weiner, EU Finance Ministers Agree on Savings Taxation; EU Hearings and Summits Address Other EU Tax Issues, 20 TAX NOTES INT'L 2731, 2731-32 (June 26, 2000). The EU member states agreed that all EU countries will eventually move to the exchange of information model. Id. at 2731. Further, the European Union will undertake efforts to encourage other third countries to participate in the exchange of information. Id.
260. OECD, HARMFUL TAX COMPETITION: AN EMERGING GLOBAL ISSUE 10 (1998) [hereinafter HARMFUL TAX COMPETITION]. The main factors to determine tax haven criteria were whether (1) the regime imposes low or no taxes on relevant income, (2) the jurisdiction facilitates the establishment of foreign-owned entities without the need for a local substantive presence, (3) the regime lacks transparency (details of the regime are not apparent or there is inadequate disclosure), and (4) there is no effective exchange of taxpayer information. Id. at 25-30.
261. Id. at 65-78.
262. See OECD, COMMITTEE FISCAL AFFAIRS, TOWARDS GLOBAL COOPERATION: PROGRESS IN IDENTIFYING AND ELIMINATING HARMFUL TAX PRACTICES 17 (June 2000) [hereinafter GLOBAL COOPERATION REPORT]. The United States was "cited for the harmful effects" of its Foreign Sales Corporations (FSC) provisions within the tax code. Id. at 14. FSCs are tax incentives that are designed to encourage exports. See I.R.C. § 922(a) (West 2000). The OECD report notes that "this Report has no bearing on [the] classification [of foreign sales corporations] or treatment in connection with trade disciplines."
263. GLOBAL COOPERATION REPORT, supra, at 14 n.11. The OECD appears to be referring to the ongoing dispute between the United States and the World Trade Organization. The United States argues that FSC provisions do not act in contravention of WTO rules against using tax incentives to encourage exports because the FSC rules ensure that income-producing economic activities take place outside the United States.
264. See APPELLATE BODY REPORT, UNITED STATES - TAX TREATMENT FOR "FOREIGN SALES CORPORATIONS" 59 WT/DS108/AB/R (Feb. 24, 2000). The WTO has held that the FSC provisions constitutes a prohibited export subsidy. Id.
265. See GLOBAL COOPERATION REPORT, supra note 200, at 12-16. With respect to identifying non-tax haven harmful practices, the main difference from the tax haven criteria is factor number 2 noted in note 198 above, which can be replaced with "whether the regime is ring-fenced from the domestic economy" (in other words, the tax benefits only apply to foreign companies). Id. at 10 n.3.
266. See id. at 24-26 (indicating that OECD member states can take defensive measures that include disallowing deductions, credits, or exemptions related to transactions with tax havens; denying availability of foreign tax credits with regard to distributions that are sourced to tax havens; or imposing "transactional" charges on certain transactions involving tax havens).
267. See I.R.S. Notice 97-24, 1997-1 C.B. 411 (warning taxpayers who participate in abusive offshore trust arrangements that they could be subjected to civil and criminal penalties). For a discussion of U.S. efforts in this area, see Lupi-Sher, supra note 178, at 176-77 (describing the efforts of IRS Assistant Commissioner John T. Lyons to focus more resources on discovering abusive tax avoidance and evasion transactions).
268. See Robert Goulder, Clinton Proposes Tax Haven Blacklist, 86 TAX NOTES 896, 896-97 (Feb. 14, 2000) (describing the Clinton Administration's proposal in the 2001 budget to create a blacklist of tax havens).
269. Lawrence H. Summers, Tax Administration in a Global Era, Address Before the 34th General Assembly of the Inter-American Center of Tax Administrators (July 10, 2000), available at http://www.treas.gov/press/release/ ps759.htm.
270. Id. (describing potential action by the Clinton Administration to combat the use of tax havens, including legislation directed at requiring the reporting of payments to tax havens, the denial of certain tax benefits for income earned in tax havens, and forcing tax haven-based banks to comply with specified requirements in order for these banks to qualify as Qualified Intermediaries under U.S. tax law).
271. Fed. Trade Comm'n v. Affordable Media LLC, 179 F.3d. 1228, 1242 (9th Cir. 1999). In this case, two U.S. taxpayers placed assets in a trust located in the Cook Islands, a tax haven. Id. at 1231. The taxpayers were advised that their assets would be protected from U.S. creditors because U.S. jurisdiction did not extend over assets placed in a foreign country which would not enforce U.S. court judgments. Id. The two U.S. taxpayers participated in a Ponzi scheme where investors lost over $13 million. Id. at 1332. The Federal Trade Commission sued the taxpayers to recover assets held in the trust in order to pay for the Ponzi scheme losses. Id. The taxpayers were unable to bring back the assets from the trust (due to a contractual provision in the trust agreement) and were held in contempt of court (and thrown in jail) for not complying with a judicial order to recover their assets held in a foreign trust. Id. at 1233. The court did not reach a decision on the more difficult issue of whether self-induced impossibility is a defense to civil contempt. Id. at 1243 n.12.
272. This Part relies to a certain extent on a previous work that offers a general discussion on the distinction between good and bad forms of international tax competition. See Arthur J. Cockfield, Tax Integration Under NAFTA: Resolving the Conflict Between Economic and Sovereignty Issues, 34 STAN. J. INT'L L. 39, 41-46 (1998). The OECD has set out criteria to distinguish between "harmful" international tax competition and "harmless" competition with respect to international financial services.
273. See HARMFUL TAX COMPETITION, supra note 198, at 13-18 (explaining that the degree of harmfulness of any tax practice ranges along a spectrum and thus the identification of harmful practices involves a balancing of factors).
274. See Jeanne-Mey Sun & Jacques Pelkmans, Regulatory Competition in the Single Market, 33 J. COMMON MARKET STUD. 67, 82-83 (1995).
275. Early work in this field was conducted by Professor Charles Tiebout who attempted to explain the process behind the market for public goods. See generally Charles M. Tiebout, A Pure Theory of Local Expenditure, 64 J. POL. ECON. 416 (1956). His model, which examined the provision of public goods by local governments in the United States, suggested that regulatory bodies would be disciplined by the public who would "vote with their feet" if they did not approve of government policies by moving to a jurisdiction with a more favorable regulatory approach. Id. at 418. In other words, there was competition for voters (and taxpayers) between the two jurisdictions. The jurisdiction that best reflected the public preference (the correct mix of tax and the provision of public goods) would attract the most voters and hence the most tax revenues. See id.
276. For a discussion of general costs and benefits of competition among government regulations, see STEPHEN WOOLCOCK, THE SINGLE EUROPEAN MARKET: CENTRALIZATION OR COMPETITION AMONG NATIONAL RULES 16-21 (1994).
277. See generally Alex Easson, Tax Competition and Investment Incentives, 2 EC TAX J. 63 (1997). Tax competition most often involves the use by a country of specific tax incentives to attract or maintain a certain type of investment. The consensus among tax policy analysts is that tax incentives for investment are rarely effective since, as noted above, direct investment is influenced by non-tax factors. The tax incentives do not generally attract investments that would not occur, but for the availability of the incentive. Thus, the incentives are made available to investors who would have made the investment even without the tax break.
278. See generally OECD, TAXATION AND FOREIGN DIRECT INVESTMENT: THE EXPERIENCE OF ECONOMIES IN TRANSITION (1995). If this is always the case, there would not be a reason to come up with multilateral mechanisms to deal with tax incentives offered to foreign companies. The country that enacted the tax incentive would only end up harming itself through foregone revenues. A race to the bottom, however, will continue to take place, at least for the medium term, as certain countries feel they have no choice other than to compete for capital against similarly-situated countries who are striving to do the same thing.
279. For example, it has been estimated that 103 countries have offered special tax benefits to foreign companies that set up production or administrative facilities within their borders. Avi-Yonah, supra note 189, at 1577.
280. See, e.g., HARMFUL TAX COMPETITION, supra note 198, at 16 (indicating that harmful tax competition leads to detrimental effects by "causing undesired shifts of part of the tax burden to less mobile tax bases, such as labour, property and consumption"). The OECD Council specifically referred to this problem as part of the justification to retaliate against harmful tax practices: Considering that if governments do not intensify their co-operation, the tax base will be eroded, a part of the tax burden will shift from income on mobile activities to taxes on non mobile activities and that such a shift would make tax systems less equitable and may have a negative effect on employment.
281. GLOBAL COOPERATION REPORT, supra note 200, at 29;
282. see also Michael J. McIntyre, Commentary, The Design of Tax Rules for the North American Free Trade Alliance, 49 TAX L. REV. 769, 773-74 (1994) (discussing how tax competition has led to the adoption of a steeply regressive tax system).
283. It was recognized that the convergence of interest and inflation rates in Europe was a principle cause of this harmonizaiton. See COMMISSION OF THE EUROPEAN COMMUNITIES, REPORT OF THE COMMITTEE OF INDEPENDENT EXPERTS ON COMPANY TAXATION, 193-219 (1992) [hereinafter RUDING COMMITTEE]. The committee, named after its chair, Onno Ruding, was mainly concerned with thwarting the development of future tax incentives designed to attract international investment. Id. These recommendations have never been implemented.
284. For a brief review of Tieboutian public choice theory, see supra note 210 and accompanying text.
285. Peggy B. Musgrave & Richard A. Musgrave, Fiscal Coordination and Competition in an International Setting, in INFLUENCE OF TAX DIFFERENTIALS ON INTERNATIONAL COMPETITIVENESS 59, 63-70 (1990) (arguing that the forces of competition cannot secure an efficient or equitable allocation of finances in the international arena). State tax competition differs from global tax competition since the former involves free trade without obstacles, comprehensive access to information, a federal tax system that establishes guidelines for individual and corporate income tax and imposes the lion's share of income taxes, and low rate retail sales taxes in contrast to high rate Value Added Taxes.
286. VITO TANZI, TAXATION IN AN INTEGRATING WORLD 29-31 (1995) (discussing lessons from the American experience for global tax integration). It is interesting to note that Canadian provinces impose greater levels of tax on individuals and business entities in comparison to U.S. states where more tax competition exists. The provinces have generally adopted the federal government's definition of the income tax base, and most provinces have collection agreements that permit the feds to collect their taxes. Of course, there may be non-tax reasons that explain the different tax burdens.
287. Since labor is generally immobile in the international context, the models hold labor immobile and focus on the competition for mobile factors, such as investment goods. John H. Beck, Tax Competition, Uniform Assessment, and the Benefit Principle, 13 J. URBAN ECON. 127, 127-29, 142 (1983) (describing how local government competition for investments leads governments in some circumstances to impose taxes on business property that are less than the cost of providing goods to the businesses).
288. See generally Joel Slemrod, Tax Cacophony and the Benefits of Free Trade, in FAIR TRADE AND HARMONIZATION: PREREQUISITES FOR FREE TRADE? 306 (Jagdish Bhagwati & Robert E. Hudec eds., 1996).
289. For OECD countries in general, corporate tax revenues have remained level for several decades. See OECD, TAXING PROFITS IN A GLOBAL ECONOMY 56 (1991) (indicating that during the 1980s, corporate tax increased in the majority of OECD countries and the OECD unweighted average for these revenues increased from 7.5% to 7.8% of total taxes); see also RUDING COMMITTEE, supra note 215, ch. 7 (concluding that there was no evidence that tax competition had led to significant corporate tax revenue downfalls within the economically integrated area of the European Community). In contrast, corporate tax revenues in the United States and Canada have been declining for several decades. TANZI, supra note 217, at 103. In contrast to the situation in most other OECD countries, corporate income tax as a percentage of the GDP has declined significantly in the United States from 3.7% of the GDP in 1970 to 2.2% of the GDP in 1991; the corresponding figures for Canada are 3.5% to 2.1%. Id. This decline, however, has been attributed to reasons other than international tax competition, at least with respect to the situation in the United States.
290. See Alan J. Auerbach & James M. Ponorterba, Why Have Corporate Tax Revenues Declined?, 1 TAX POLICY & THE ECONOMY 1, 20 (1987) (concluding that domestic legislative changes and, more importantly, a decline in corporate profits, have contributed to lower corporate revenues);
291. see also Roger H. Gordon & Joel Slemrod, Do We Collect Any Revenue from Taxing Capital Income?, 2 TAX POLICY & THE ECONOMY 89, 120 (1988) (arguing that the different methods of taxing capital income lead to arbitrage opportunities that reduce revenues). Further, the United States and Canada continue to impose significant additional taxes on businesses, primarily employer's social security contributions and payroll taxes. TANZI, supra note 217, at 106-07 (discussing the debate surrounding whether or not these additional taxes should be properly characterized as falling on labor). In 1989, these additional taxes constituted 6.5% of the GDP for the United States and 3.6% of the GDP for Canada. Id. at 107. There is evidence that Canadian tax authorities have felt pressure to conform parts of their tax systems to the United States. Canadian effective tax rates on capital income have been gradually reduced in the last twenty years until the Canadian system imposed a similar tax burden on-capital activity as the one imposed by the U.S. tax system.
292. See KENNETH J. MCKENZIE & AILEEN J. THOMPSON, TAXES, THE COST OF CAPITAL, AND INVESTMENT: A COMPARISON OF CANADA AND THE UNITED STATES 14 (1997) (concluding that convergence is mainly attributable to a convergence in real interest rates);
293. see also Kenneth J. McKenzie & Jack M. Mintz, Tax Effects on the Cost of Capital, in CANADA-U.S. TAX COMPARISONS 189, 207 (John B. Shoven & John Whalley eds., 1992) (noting that the convergence may not have been deliberate).
294. See, e.g., HARMFUL TAX COMPETITION, supra note 198, at 17-18. Although it is difficult to quantify the harmful effects of tax competition, "countries would agree that such regimes are harmful and should be discouraged." Id. In fact, the Ruding Committee encountered difficulties in measuring the costs attributable to the interaction of the tax regimes of the different European Community member states. See RUDING COMMITTEE, supra note 215, at 197. It was indicated that the Committee has found no satisfactory way of quantifying the size of this misallocation [of resources] . . . . Nevertheless, the fact that empirical evidence gathered on behalf of the Committee indicates that taxation does have a strong influence on the location of investment and on financing decisions is prima-facie evidence that the distortions to competition and resulting efficiency losses caused by taxation could be large. Id. at 197-98 (emphasis added). The Ruding Committee indicated that, among the member states, a general convergence of corporate income tax rates to a lower rate was consistent with (although not necessarily proof of) tax competi-tion among these states. See id. at 199-200.
295. Robert Goulder, OECD Symposium Asks, Do Tax Havens Really Work?, 2000 TAX NOTES TODAY 129-6, 129-6.
296. The European Union has attempted to distinguish between harmful and beneficial forms of tax competition by setting out the following criteria in its business tax code of conduct (which came into effect January 1, 1998): When assessing whether such [tax] measures are harmful, account should be taken of, inter alia: 1. whether advantages are accorded only to non-residents or in respect of transactions carried out with non-residents, or 2. whether advantages are ring-fenced from the domestic market, so they do not affect the national tax base, or 3. whether advantages are granted even without any real economic activity and substantial economic presence within the Member State offering such tax advantages, or 4. whether the rules for profit determination in respect of activities within a multinational group of companies departs from internationally accepted principles, notably the rules agreed upon within the OECD, or 5. whether the tax measures lack transparency, including where legal provisions are relaxed at administrative level in a non-transparent way. ECOFIN COUNCIL CONCLUSIONS CONCERNING TAXATION POLICY, 1998 O.J. (62) 1,
297. reprinted in EC Update, 38 EUR. TAX'N EC-5 (1998) (proposing that a special group be formed to identify the harmful tax measures and to oversee dismantling of the measures by January 1, 2003).
298. See GLOBAL COOPERATION REPORT, supra note 200, at 15. With respect to taxpayers who benefited from harmful regimes that were in place on December 31,
299. Id. at 18-19.
300. See supra notes 7-8 and accompanying text.
301. See LESSIG, supra note 7, at 30-42. In fact, Lessig asserts that governments should refuse to do so at their peril. Id. at 29. To Lessig, unrestricted commercial developments will lead to a kind of control, even if government abdicates its responsibility to regulate. See id.
302. Id. at 107.
303. Unlike previous forms of static government regulation, it is likely governments will have to develop a more flexible approach that takes into consideration the dynamic and decentralized nature of the Internet. As the example involving Gnutella and Freenet makes clear, insurgents will always be developing code that can undermine government's efforts to regulate the Internet. See supra note 117 and accompanying text. Government regulation will have to constantly respond and adopt to these new developments, effectively requiring a counter-insurgent mentality to redress damage. Lessig suggests that governments will have a more difficult time in regulating an Internet that relies on open source code (like Apache or Linux) because open code is easier for third parties to manipulate in comparison to closed code (like Microsoft 98). See Lawrence Lessig, The Limits in Open Code: Regulatory Standards and the Future of the Net, 14 BERKELEY TECH. L.J. 759, 764 (1999).
304. Id. at 763.
305. The majority of tax literature on this topic discusses, as this article has done, the complications surrounding the taxation of e-commerce. Significant progress, however, has been made by tax authorities to ease compliance efforts for taxpayers using Internet technologies, such as filing online tax returns. For IRS efforts in this area, see IRS e-file, at http:/www.irs.gov/ elec_svs/index.html (last visited Jan. 31, 2001). Over thirty-five million Americans filed electronically for fiscal year 1999, and the IRS website attracted 791 million hits in one year, making this website one of the most frequently visited sites on the Internet. See Summers, supra note 205.
306. See generally Legislation with Regard to Taxation of Electronic Commerce: Hearing on H.R. 4267, H.R. 4460, H.R. 4462 Before the SubComm. On Commercial and Administrative Law of the House Comm. on the Judiciary, 106th Cong. (2000) (statement of Sen. Stephen Saland, NY Senate, Vice-Pres., Nat'l Conf. of State Legis.), available at http://www.ncsl.org/programs/press/ hjctest.html (discussing the efforts by eighteen participating states to develop an Internet-based solution to reduce or eliminate the costs associated with sales tax compliance).
307. The OECD Technology Technical Advisory Group is reviewing, among other things, the feasibility of developing identification practices for businesses engaged in e-commerce, digital signatures, and compatible electronic tax records. See generally Jeffrey Owens, Taxation in the Wired World (May 2000), at http://www.oecd.org/subject/e_commerce. In addition, the OECD Professional Data Assessment Advisory Group is reviewing, among other things, the practicality of developing internationally compatible information and record-keeping requirements for tax authorities. Id.
308. See generally Duncan Bentley & Patrick Quirk, A Proposal for Electronic Transactions Tax Collection in the Context of Tax-Driven Reform of Banking Laws, 10 J. INT'L BANKING L. 327 (1999);
309. Duncan Bentley, A Model for Electronic Tax Collection (forthcoming) (draft on file with author).
310. Other scholars propose replacing the federal and state income, sale/excise, gift, and estate taxes with a low rate tax that is automatically assessed and collected on most payments for goods and services. See generally Patrick R. Colabella & Richard J. Coppinger, The Withdrawals Tax (forthcoming) (draft on file with author).
311. Nations are often reluctant to share taxpayer information due to concerns surrounding the privacy rights of their residents. An additional problem exists where some countries refuse to share information with a requesting country if the actions of an individual being investigated by the requesting country would not be considered illegal in the other country. A recent OECD report, approved by all twenty-nine member states, recommends, among other things, heightened taxpayer information exchanges with identification numbers for taxpayers. See generally OECD, COMMITTEE ON FISCAL AFFAIRS, IMPROVING ACCESS TO BANK INFORMATION FOR TAX PURPOSES (2000), available at http://www.oecd.org/publications/e-book/2300031e.pdf. The subsequently discussed extranet could facilitate this process.
312. See, e.g., GLOBAL COOPERATION REPORT, supra note 200, at 20 (proposing a multilateral "OECD Model Tax Information Exchange Agreement" to assist cooperative jurisdictions to combat harmful tax competition in the context of mobile financial and other services). As part of its efforts to effectively tax cross-border savings, EU nations plan to strive to include key third countries in its information exchange procedures. See Weiner, supra note 197, at 2732. The European Union has already implemented multilateral dispute resolution procedures to help eliminate international double taxation in context of transfer pricing.
313. See generally Convention 90/436/EEC on the Elimination of Double Taxation in Connection with the Adjustment of Profits of Associated Enterprises, 9 TAX NOTES INT'L 78 (1995).
314. In order to protect taxpayer privacy, it may not be feasible to give financial intermediaries access to this extranet. A more realistic solution would be to have each national tax authority set up an intranet where information concerning cross-border transactions is fed to them by domestically-based financial intermediaries. The tax authorities could then share, if required, this transactional information with other participating tax authorities.
315. See Edward Cone, Cash Machine, WIRED, June 1, 2000, at 269 (describing efforts by State Street to use its Global Link extranet to connect customers).
316. Marshall N. Carter, How Technology is Forging a Revolution in Financial Markets, Address at the Hotel Okura Executive Luncheon (June 25, 1999), at http://www.statestreet.com (discussing efforts by State Street to erect an information infrastructure to handle the flow of data associated with trillions of dollars in investments).
317. But see H. David Rosenbloom, Sovereignty and the Regulation of International Business in the Tax Area, 20 CAN.-U.S. L.J. 267, 268 (1994) (arguing that, although multilateral tax treaties are warranted in theory, in practice and administration, it "is virtually impossible to pass beyond the bilateral level"). There are a number of reasons why tax authorities prefer to maintain bilateral negotiation of tax treaties, including the fact that bilateral negotiation permits a treaty to be tailored to unique matters that often arise between two particular countries, such as cross-border pension matters with neighboring countries. A multilateral agreement, however, should be extended at a minimum to rules dealing with an exchange of taxpayer information because this necessarily involves all countries.
318. For a discussion surrounding a possible move toward a multilateral OECD Model Tax Treaty, see generally MICHAEL LANG ET AL., MULTILATERAL TAX TREATIES: NEW DEVELOPMENTS IN INTERNATIONAL TAX LAW (1998).
319. Most countries will not have the financial or technical resources to implement the extranet. The program, however, could still be successful if most OECD member states implemented the extranet, as the problems associated with capital flight and harmful tax competition generally involve these countries.
320. See, e.g., Froomkin, supra note 109, at 153-54 ("The same technology that would enable tax cheating would vastly enhance the capability of tax collectors to amass transactional data about citizens; if the state is willing to collect this data aggressively, tax cheating may actually become more difficult, not more common.").
321. See supra note 197 and accompanying text.
322. Professor Avi-Yonah has suggested the United States could unilaterally impose a withholding tax to signal to other countries that it will cooperate with multilateral efforts like the recent EU efforts. See Avi-Yonah, supra note 189, at 1667-69. Under Avi-Yonah's proposal as well as the EU Savings Directive, the investor could obtain a refund on the taxes if the investor reports the interest income to his own tax authorities. See id. at 1650. "For portfolio investment, for example, a nation could have either a final withholding tax, which would accrue to the host jurisdiction, or a refundable withholding tax, which would be refunded upon proof that the income was reported to the home jurisdiction." Id. Unilateral action of this sort, however, is probably unworkable in the arena of international taxation, compared to other more successful unilateral efforts like reducing tariffs for trade purposes. Under neo-classical economic theory, a country will be better off if it unilaterally reduces its tariffs on the import of goods into the country. Free trade both promotes a country's economic self-interest and improves overall global welfare. Taxation is different. Taxes imposed unilaterally on mobile capital drives the capital out of the imposing country and into another, lower-taxed country. For example, when Germany imposed a 10% withholding tax on interest, "[t]he experience was a negative one . . . . Only a few months after coming into force, the withholding tax, introduced in 1988, had to be abolished, even though the rate of tax was fixed at only 10 percent." Leif Muten, International Experience of How Taxes Influence the Movement of Private Capital, 8 TAX NOTES INT'L 743, 745-46 (1994).
323. Congress repealed the withholding tax on portfolio interest in 1984 for several reasons, including the need to permit U.S. corporations to directly access the Eurobond market. See General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984, in SAMUEL C. THOMPSON, JR., U.S. TAXATION OF INTERNATIONAL TRANSACTIONS 86, 86-88 (1995).
324. Professor Avi-Yonah notes that under current conditions, the reasons that led to the enactment of the portfolio interest exemption no longer exist. Avi-Yonah, supra note 189, at 1667. The United States, however, remains the largest debtor nation in the world and, despite current budgetary surpluses, it continues to need foreign capital to finance domestic operations. See OECD, INTERNATIONAL DIRECT INVESTMENT STATISTICS YEARBOOK 12 (1997) (foreign direct investment in the United States rose from $18,885 million in 1992 to $84,629 million in 1996). Avi-Yonah indicates that the "United States could probably repeal the portfolio interest exemption immediately without suffering adverse consequences." Avi-Yonah, supra note 189, at 1667. Yet, if capital leaves the United States due to the imposition of a withholding tax, U.S. interest rates would likely rise to re-attract the necessary amount of foreign capital. The specter of potentially higher interest rates along with higher capital costs for new investments would probably make such unilateral action politically infeasible without assurances that a massive outflow of capital will not take place.
325. Professor Avi-Yonah notes that the "withholding tax would generally apply only to payments made to non-OECD member countries" because OECD member states already typically feature bilaterally negotiated tax treaties. Avi-Yonah, supra note 189, at 1669.
326. See REPORT OF THE TECHNICAL COMMITTEE ON BUSINESS TAXATION § 6.24 (1997) (submitted to the Minister of Finance, Government of Canada), available at http://www.fin.gc.ca/taxstudy/tsrep_e.pdf [hereinafter BUSINESS TAXATION REPORT]. Withholding taxes "impede cross-border income and capital flows, and act as a tariff on the importation of capital or knowledge," especially when the taxes are not fully creditable in the home country of the investor. Id. Withholding taxes also create (1) potential compliance costs because taxpayers often must file a tax return in order to obtain a refund (assuming the tax is refundable); (2) additional rules in the source country to ensure the withholding tax is enforceable, like filing requirements for the taxpayer; and (3) resource waste from taxpayer efforts to circumvent the withholding tax. For a discussion of these points, see Cockfield, supra note 11, at 203-04. Many of these problems can be mitigated by a low withholding tax rate.
327. Sanction may be too strong a word because non-participating countries may simply not have the resources to enter into the secure extranet. In any event, many of these non-participating countries would prefer to see the participating countries assess a withholding tax on portfolio interest because investors must report the withholding tax to their domestic tax authorities in order to receive a refund. Thus, many non-participating countries would also benefit from the extranet because it would curtail the ability of their residents to avoid payment of taxes on their interest income from their cross-border portfolio investments.
328. Alternatively, it may be possible to simply target countries that act as tax or data havens. The OECD has recently put together a blacklist of thirty-five countries that arguably promote "harmful" tax competition by enabling the circumvention of international tax laws. See supra note 200 and accompanying text.
329. I.R.C. § 871(h)(5) (West 2000); see also 26 C.F.R. § 1.871-14 (1999). A U.S. payor receives a statement indicating the beneficial owner of the interest is not a U.S. person on obligations made to a non-participant, such as a tax haven intermediary, issued in registered form. 26 C.F.R. § 1.871-14(c)(1)(ii)(C) (1999). The United States currently only provides investment information from foreign investors to the Canadian government.
330. See discussion supra Part II.A.2.
331. See supra note 186 and accompanying text.
332. Tax havens arguably promote global efficiency by acting as an intermediary for international investments. As such, there is an argument that tax havens should be permitted to join the extranet. This would be possible as long as the tax haven, in turn, notified the country of residence of the transaction. In this way, if Salvatore used participating Cayman Islands as his intermediary, the Cayman Islands would agree to notify the Argentine government of the transaction. It is doubtful, however, that tax havens would participate in such a scheme. Most tax havens have bank secrecy laws making it a criminal offense to divulge client information to third parties.
333. See GLOBAL COOPERATION REPORT, supra note 200, at 25. The report lists "possible defensive measures" that could similarly be instituted with the help of the proposed secure extranet, including disallowing deductions, credits, or exemptions related to transactions with tax havens, denying availability of foreign tax credits to distributions sourced to tax havens, or imposing charges on certain transactions involving tax havens. See id.
334. This is the proposed approach to dealing with uncooperative tax havens being developed by the OECD and United States. See supra notes 198-207 and accompanying text. A Senate Committee recommended a similar approach in 1985. See generally SENATE COMMITTEE REPORT, supra note 190 (recommending, inter alia, the denial of any deduction for U.S. tax purposes for any expense or loss arising out of a transaction entered into with an entity located in a tax haven and requiring that U.S. corporations report income earned through tax havens as U.S. source income).
335. HARMFUL TAX COMPETITION, supra note 198, at 29-30.
336. See id. Jeffrey Owens, OECD Head of Fiscal Affairs, has elaborated on the requisite international standards that would permit home countries to tax the foreign activities of their residents: The international standard means, for example: (1) The beneficial ownership of shares and trusts must be kept on records that can be accessed by governmental authorities. (2) There are audited or filed financial accounts. (3) There is an efficient administrative process to all the tax authorities of another state to obtain information needed to enforce its own revenue laws with regard to geographically mobile income.
337. For a more expansive discussion on income shifting strategies employed by multinational firms, see David Harris et al., Income Shifting in U.S. Multinational Corporations, in STUDIES IN INTERNATIONAL TAXATION 277, 301-02 (Albert Giovannini et al. eds., 1993) (concluding that, for U.S. manufacturing companies with extensive holdings in different countries, income shifting significantly reduces U.S. tax liabilities while, for multinational firms as a whole, income shifting leads to moderate reductions in U.S. tax liabilities); Cooper, supra note 259, at 43-44 (indicating survey results demonstrate 52% of subsidiaries are mainly concerned with compliance through their transfer pricing efforts while 23% report optimizing tax arrangements is a main priority in shaping transfer pricing policy).
338. For U.S. procedures, see Rev. Proc. 96-53, 1996-2 C.B. 375; see also INTERNAL REVENUE SERVICE, OFFICE OF THE ASSISTANT COMMISSIONER (INTERNATIONAL) ET AL., REPORT ON THE APPLICATION AND ADMINISTRATION OF SECTION 482, ch. 6 §§ 3-4 (1999), available at http://ftp.fedworld.gov/pub/ irs_pdf/p3218.pdf (outlining purposes, objectives, and administrative details of the APA process).
339. Taxpayers who wish to aggressively pursue income shifting strategies, however, will not likely want to participate in an APA because the tax authorities will generally assert a need to find a middle-ground solution. The extranet, however, may make it more difficult to employ these aggressive strategies. If so, these taxpayers will have a greater incentive to resort to APAs. Twelve percent of respondents to a survey on transfer pricing reported having used an APA in 1999 while 45% of respondents reported they would consider using an APA in the future. See Cooper, supra note 259, at 47.
340. Complicated non-arm's length transactions involving intangible goods and services are often better addressed through formulas assigning profit margins to certain activities. See Avi-Yonah, supra note 23, at 545-50.
341. This software could form part of the international online tax clearinghouse. See discussion infra Part III.B.3.
342. For a discussion on the topic, see JOANN M. WEINER, USING THE EXPERIENCE IN THE U.S. STATES TO EVALUATE ISSUES IN IMPLEMENTING FORMULA APPORTIONMENT AT THE INTERNATIONAL LEVEL, pt. IV (1999), available at http://www.treas.gov/ota/ota83.pdf (concluding the economic conditions permitting states to use formulary apportionment do not exist at the international level).
343. For a consideration of formulary apportionment in the NAFTA context, see generally Paul R. McDaniel, Formulary Taxation in the North American Free Trade Zone, 49 TAX L. REV. 691 (1994). For a discussion of moving toward formulary apportionment for e-commerce, see Cockfield, supra note 11, at 172-75 (concluding it is unlikely that formulary apportionment would be implemented due to concerns about fiscal sovereignty and the neutral tax treatment of e-commerce versus traditional commerce).
344. Most tax authorities and international organizations are opposed to formulary apportionment, largely because governments must cede fiscal sovereignty to a supranational authority that determines the rules which will determine how revenues are divvied up. See BUSINESS TAXATION REPORT, supra NOTE 248, § 6.16;
345. OECD COMMITTEE ON FISCAL AFFAIRS, TRANSFER PRICING GUIDELINES FOR MULTINATIONAL ENTERPRISES AND TAX ADMINISTRATIONS, PART I: PRINCIPLES AND METHODS 65-68 (1994);
346. RUDING COMMITTEE, supra note 215, at 203. Formulary apportionment has been criticized for, among other things, increasing compliance and enforcement burdens, creating the technical problem of defining a "unitary enterprise" and ignoring the difficulty of approximating existing revenues, and of using standard formula where industry practices may vary. See John S. Brown, Commentary, Formulary Taxation and NAFTA, 49 TAX L. REV. 759, 761-67 (1994).
347. But see WEINER, supra note 268, pt. III.F.1 (asserting companies can continue with income shifting activities under formulary apportionment by altering how they value apportionment factors by, for example, reassigning the location of its sales or hiring independent contractors in a low-tax area).
348. See, e.g., STEFIK, supra note 9, at 393-94.
349. LESSIG, supra note 7, at 39-42. Lessig coined this term to describe a framework for relations between businesses and individuals. See id. Lessig also discusses the potential dark side of a government/business regulatory partnership that could trample over individual freedoms such as the right of privacy. Id. at 142-63.
350. GAIL L. GRANT, UNDERSTANDING DIGITAL SIGNATURES: ESTABLISHING TRUST OVER THE INTERNET AND OTHER NETWORKS 14 (1998), excerpted in LESSIG, supra note 7, at 40.
351. Vinton Cerf, What Will Replace the Internet?, TIME.COM (June 19, 2000), at http:/www.time.com/time/reports/v21/tech/mag_web.html.
352. One hundred million Americans use cell phones. Sylvia Dennis, CTIA Celebrates 100 Million Wireless Customers, MICROTIMES.COM (July 27, 2000), at http:/www.microtimes.com/newsfeeds/julyfeeds%2000/july27.html. Many cell phones are currently sold with the capacity to connect to the Internet.
353. See Ronna Abramson, Ford, Qualcomm Join Forces to Create Wireless Vehicles, THE INDUSTRY STANDARD (Aug. 2, 2000), at http://www.cnn.com/ 2000/TECH/computing/08/02/qualcomm.on.board.idg.
354. For a discussion of network security issues, see generally Michael Lee et al., Electronic Commerce, Hackers, and the Search for Legitimacy: A Regulatory Proposal, 14 BERKELEY TECH. L.J. 839 (1999). A survey conducted by Ernst & Young found that nearly half of 1290 businesses were the victims of online security breaches.
355. Marc S. Friedman & Kristin Bissinger, 'Infojacking': Crimes on the Information Superhighway, 9 J. PROPRIETARY RTS. 2, 7 (1997). Further, U.S. federal law enforcement officials estimate that over $10 billion dollars worth of data is stolen from U.S. businesses each year. Id.;
356. see also Ursula Sautter, To Catch a Thief, TIME.COM, at http://www.time.com/ time/europe/specials/eeurope/field/thief.html (last visited Jan. 31, 2001) (discussing the difficulties associated with tracing computer crimes back to hackers).
357. It is recognized that hackers "spoof" (pretend to be someone else) in order to gain access to particular computers or to launch barrage attacks.
358. For example, as Jeff Carpenter of the Computer Emergency Response Team (CERT) Coordination Center, a federally financed network security organization, warned, with regard to the Love Bug virus, "Without architectural improvements [to the Internet] we will see this again." Grossman, supra note 1, at 56. Modification of current Internet Protocol language will aid in authentication, data integrity, and confidentiality. See William A. Hodkowski, Comment, The Future of Internet Security: How New Technologies Will Shape the Internet and Affect the Law, 13 SANTA CLARA COMPUTER & HIGH TECH. L.J. 217, 220 (1997). Hackers recently brought down large parts of the Internet by launching barrage attacks, which are essentially millions of requests for information that overload a company's server infrastructure.
359. See Nathaniel Wice, Smurf Assault Cripples More Big Sites, TIME DIGITAL (Feb. 9, 2000), at http://www.time.com/time/digital/daily/0,2822,38968,00.html (describing how "denial of service" attacks brought down the most highly trafficked commercial websites on the Internet, including Yahoo!, Amazon.com, eBay, and Buy.com).
360. See, e.g., CANADIAN REPORT, supra note 14, ¶ 4.2.1.2. (noting that certain companies may not be able to comply with foreign tax laws due to the difficulties associated with identifying the consumer's country of residence).
361. The decentralized nature of the Internet - an interconnection between computer networks with no central organization structure - makes identification issues very complex. Instead of a central computer, the Internet uses "routers" that consist of hundreds of thousands of computers that route information packets to their ultimate destination. As a result, it may be impossible to link a consumer's personal computer. A vendor's server could, at best, identify the Internet Protocol address of the consumer's Internet Service Provider (ISP), although even the ISP may have no relationship to the consumer's home country. Further, end users can employ encryption technology to protect their data from unauthorized disclosure or viewing. The situation becomes further complicated as end consumers begin to use "unaccounted" electronic payment systems where they will not be identified as a party to the transaction and no independent records will be kept. Some of the new electronic payment systems, including e-cash and stored value cards, are designed to operate as unaccounted systems. Finally, the use of anonymizing technologies will inhibit the ability of vendors or tax authorities to identify the location of consumers. See Cockfield, supra note 11, at 180-82.
362. A company called Akamai has developed software that permits e-commerce companies to determine the geographic location of their website visitors by mapping the visitors' Internet Protocol addresses. For an explanation of this service, see How EdgeScape Works homepage, at http://www.akamai.com/html/en/sv/edgescape_works.html (last visited Feb. 17, 2001). There has also been discussion of creating a "resident card" that identifies the country of the e-commerce consumer.
363. See Internet Taxation System Is Mulled by White House, WALL ST. J., Sept. 11, 1998, at B4. The resident card proposal, however, never really left the ground.
364. Following is a more elaborate definition: A digital certificate is an electronic "credit card" that establishes your credentials when doing business or other transactions on the Web. It is issued by a certification authority (CA). It contains your name, a serial number, expiration dates, a copy of the certificate holder's public key (used for encryption messages and digital signature), and the digital signature of the certificate-issuing authority so that a recipient can verify that the certificate is real. Some digital certificates conform to a standard, X.509. Digital certificates can be kept in registries so that authentication users can look up other users' public keys. WHATIS.COM, Digital Certificate, at http://www.whatis.techtarget.com/ WhatIs_Definition_Page/0,4152,211947,00.html (last modified July 31, 2000). One commentator has noted the problems associated with portable computers that can be easily moved across national boundaries. STEFIK, supra note 118, at 105. If a French resident carries her laptop computer into the United States and then downloads software from a U.S.-based publisher, should the transaction be subject to French taxation? See id. One approach would involve registering computers in the country where the user is based. See id. According to Stefik, these computers "could carry digital certificates that would authenticate their nation of registry no matter where they are in the world." Id. If the French resident has a digital certificate that identifies the computer as "resident" in France, the transaction should presumably be subject to French taxation despite the fact that the downloading physically takes place in the United States. See id.
365. For a discussion of trusted third parties in the context of digital signatures, see A. Michael Froomkin, The Essential Role of Trusted Third Parties in Electronic Commerce, 75 OR. L. REV. 49, 114 (1996) (explaining that third party certification authorities may become essential to much electronic commerce);
366. see also Brian W. Smith & Paul S. Tufaro, To Certify or Not to Certify? The OCC Opens the Door to Digital Signature Certification, 24 OHIO N.U. L. REV. 813, 813 (1998) (noting that certification authorities are pivotal to the growth of electronic commerce and electronic banking).
367. See Electronic Signatures in Global and National Commerce Act, Pub. L. No. 106-229, 114 Stat. 464 (2000). This legislation permits individuals to use binding electronic signatures for interstate or foreign commerce. See id. A digital signature has been defined as follows: A digital signature (not to be confused with a digital certificate) is an electronic rather than a written signature that can be used by someone to authenticate the identity of the sender of a message or of the signer of a document. It can also be used to ensure that the original content of the message or document that has been conveyed is unchanged. Additional benefits to the use of a digital signature are that it is easily transportable, cannot be easily repudiated, cannot be imitated by someone else, and can be automatically time-stamped. A digital signature can be used with any kind of message, whether it is encryption or not, simply so that the receiver can be sure of the sender's identity and that the message arrived intact. A digital certificate contains the digital signature of the certificate-issuing authority so that anyone can verify that the certificate is real. WHATIS.COM, Digital Signature, at http://whatis.techtarget.com/WhatIs_ Definition_Page/0,4152,211953,00.html (last modified Oct. 23, 2000).
368. See supra note 272 and accompanying text; see also Smith & Tufaro, supra note 284, at 829 (asserting that digital signature certification "will likely play a crucial role in the marketplace of the future").
369. The technology, for example, could simply identify the location of a user's ISP without resorting to the individual's specific home address. This would permit individuals to maintain a certain level of privacy while permitting tax authorities to identify the country of consumption. It is recognized that an ISP address need not necessarily relate to the country location of all individuals, but the ISP address will likely match up with an individual's country for the vast majority of Internet users.
370. Unfortunately, many local tax jurisdictions cross zip code jurisdictions. See DEAN ANDAL, A UNIFORM JURISDICTIONAL STANDARD: APPLYING THE SUBSTANTIAL PHYSICAL PRESENCE STANDARD TO ELECTRONIC COMMERCE 15 (Nov. 5, 1999) (unpublished proposal) (on file with author).
371. See LESSIG, supra note 7, at 41 (noting that the "key [to success of digital certificates] is not that a government requires people to hold" such certificates); see also SWIRE & LITAN, supra note 142, at 211 ("In studying these business models, we believe it would be foolhardy for national or supranational regulators to determine in advance the rules for conducting transactions over the Internet. . . . A great deal of both technological and legal experimentation is needed.").
372. LESSIG, supra note 7, at 41. Lessig uses the example of cookies to back up his point. See id. From a user's perspective, cookies are both good and evil. See id. A cookie can be considered evil because the website uses the cookie to track the Internet user's surfing habits, which constitutes an infringement of the user's privacy. See id. Cookies, however, are also good because they transmit passwords to websites (thus, relieving the user from memorizing all of her passwords) and permit access to the websites. See id. Web browsers, like Netscape, notify Internet users prior to planting a cookie on a user's hard drive, but, as Lessig notes, most users simply accept the cookies without notification because this facilitates surfing from site to site. See id. Users, therefore, accept the intrusion into their privacy because this represents the path of least resistance. See id. at 41-42. Lessig does not point out, however, that the vast majority of users may be entirely ignorant of the existence of cookies and the intrusion on their privacy.
373. Id. at 42 ("Life will be easier for those who carry ID than for those who do not. Servers will make exchanges cheaper, or simpler, if data can be authenticated.").
374. See supra note 15 and accompanying text. The House of Representatives has passed legislation that would extend the Internet Tax Freedom Act until October 2006. See id. The bill is pending before the Senate. See id. This legislation is flawed for at least three reasons: (1) there will almost certainly be significant revenue losses to state and local governments by 2006 due to their inability to tax many consumer Internet transactions; (2) the legislation fails to signal to the online industry that it must comply with sales tax laws, and therefore, fails to provide the industry with the incentive to develop effective Internet technologies to facilitate tax collection; and (3) by maintaining the Internet as a no-tax zone, the legislation treats economically equivalent transactions (the sale of a real book from a traditional bookstore verses the sale of a digital book from an online retailer) in a different manner, which will lead to distortions in the market place and arbitrage activities by traditional retailers. For example, WalMart has announced plans to open an online affiliate in a zero sales tax state in order to compete against online retailers; this is likely to lead to further revenue losses by local and state governments. For perspectives on both sides of the debate, see Arthur Cockfield & Michael Folz Wexler, Taxing Internet Sales, SAN DIEGO LAW., Sept.-Oct. 2000, at 19-20.
375. For example, California legislators recently passed a bill that requires online sellers to collect sales taxes in California if these companies are affiliated with companies that maintain a physical presence within the state. See A.B. 2412, 1999-2000 Leg. (Cal. 2000). California Governor Gray Davis, however, vetoed this bill.
376. See Commission Proposal for a Council Directive Amending Directive 77/388/EEC as Regards the Value Added Tax Arrangements Applicable to Certain Services Supplied by Electronic Means, COM(2000)349 final at 22, available at http://europa.eu.int/comm/taxation_customs/proposals/taxation/ com349_2000/com2000_349.pdf (proposing to require non-EU companies to collect VAT on sales to EU consumers of digital products).
377. See id. Non-EU online companies with above threshold sales would have to register for VAT in one member state. See Gary Burnes & Peter R. Merrill, Businesses and Governments Express Concern About European Commission's Proposed E-Commerce VAT Directive, 20 TAX NOTES INT'L 2750, 2751 (2000).
378. See VITO TANZI & LUDGER SCHUKNECHT, PUBLIC SPENDING IN THE 20TH CENTURY: A GLOBAL PERSPECTIVE 55-59 (2000) (citing data which shows that the average indirect taxes for seventeen industrialized countries rose from 11.6% of the GDP in 1960 to 13.5% in 1994);
379. see also OECD, WORKING PARTY NO. 1 ON HARMONIZATION OF TURNOVER TAXES 2 (1999) (indicating that, in addition to contributing roughly a fifth of tax receipts for EU member states, VATs pay for 44% of the EC's budget); Avi-Yonah, supra note 189, at 1619 (citing studies indicating that OECD members have increased their VAT revenues from 12% of total tax revenues in 1965 to 18% in 1995).
380. See Burnes & Merrill, supra note 295, at 2752 (indicating that the draft directive sets a "dangerous precedent for extra-territorial application of EU law"). But see ABA LONDON DRAFT, supra note 174, at 40 (noting that the U.S. Supreme Court in non-tax cases has found that jurisdiction is constitutionally permissible even though a defendant had never been physically present in the forum). "Acts outside the state, the Court reasoned, which in one way or another could be said to target residents of the state, did invoke the benefits and protections of state law . . . ." Id. 298. The European Union will attempt to address compliance concerns through the development of an electronic filing system where non-EU businesses will only have to register in one EU member state, even though these businesses may conduct transactions in other EU member states.
381. Chuck Gnaedinger, EU Trade Official Comments on Proposed VAT Changes for E-Commerce, 20 TAX NOTES INT'L 2647, 2648 (2000).
382. See discussion supra Parts I.B, I.C.
383. See, e.g., NATIONAL TAX ASSOCIATION, COMMUNICATIONS AND ELECTRONIC COMMERCE TAX PROJECT: FINAL REPORT i-ii (1999) (noting that 7600 taxing jurisdictions impose significant tax burdens on multi-state vendors, especially smaller online companies participating in e-commerce).
384. See ADVISORY COMMISSION REPORT, supra note 12, at 19-20. While the exact impact of e-commerce on sales tax revenues may be uncertain, clearly the need for substantial sales tax simplification is necessary in this emerging digital economy. . . . Most, if not all, of the Commissioners expressed the view that fundamental uniformity and simplification of the existing system are essential. The need for nationwide consistency and certainty for sellers as well as the need to alleviate the financial and logistical tax collection burdens and liability of sellers were common themes throughout discussions. Id. at 18-19. The Commission recommended that a new advisory commission should be struck to review, after states have taken steps to unify their tax systems, whether sales taxes should be imposed for Internet transactions. Id. at 20.
385. For calls for federal action to ensure state tax systems can effectively enforce taxes against remote vendors, see generally Robert P. Strauss, Federal Tax Mechanisms to Enable State Taxation of Final Consumption, 87 TAX NOTES 1657 (2000).
386. See ADVISORY COMMISSION REPORT, supra note 12, at 42-43. The Commission noted that it was not well informed as to the international ramifications of domestic U.S. tax law and called for increased oversight in this area. Id. at 43.
387. See STEFIK, supra note 118, at 83-85; see also Mark Stefik, Trusted Systems, SCIENTIFIC AMERICAN, Mar. 1997, at 78, available at http://www. sciam.com/0397issue/0397stefik.html.
388. STEFIK, supra note 118, at 104.
389. Bentley and Quirk focus on financial institutions and electronic money providers as the logical intermediary in any automated collection system. Bentley & Quirk, supra note 234, at 336. They discuss how governments could license these financial institutions so that, for example, the financial institution will not accept electronic money from an unlicensed financial institution. See id.
390. See, e.g., ABA LONDON DRAFT, supra note 174, at 171 (noting that intermediaries which provide financing mechanisms tend to be "large, sophisticated and economically strong" and therefore "could be asked to take a larger role in the tax collection mechanism, relieving the vendors of that burden").
391. Some states pay retailers in a similar manner to compensate the retailers for the additional costs associated with collecting the taxes. Paying the online intermediaries would have the obvious benefit of providing an incentive for these intermediaries to collect taxes.
392. Alternatively, each tax authority could set up an automatic system at a designated "choke point" on the Internet to monitor and assess appropriate taxes on incoming transactions. The appropriate amounts would be noted in a centralized databank that would track all inflows and outflows.
393. For a description of Taxware products, see Taxware homepage, at http://www.taxware.com/ZProducts/internet/internet.htm (last visited Mar. 16, 2001). Two years ago, Jon W. Abolins, the Manager of Tax Research at Taxware, stated that the company is unable to assist merchants in identifying the location of their customers and that the software relies on the business itself to ascertain the physical location of their customers. See Cockfield, supra note 11, at 182 n.215.
394. Countries could then credit (or debit) each others' accounts on, perhaps, a quarterly basis. This approach would be better suited for sales and VAT issues where the imposition of a tax on consumption activities is much easier to accomplish (versus the multiple types of income that can arise in the international income tax arena). See SHAPIRO, supra note 7, at 222 (discussing how online transactional intermediaries could split tax receipts among several different jurisdictions); Henry H. Perritt, Jr., Jurisdiction in Cyberspace: The Role of Intermediaries, in BORDERS IN CYBERSPACE, supra note 9, at 164, 180-81 (discussing how online intermediaries can perform different value-adding functions).
395. Bentley & Quirk, supra note 234, at 333-34.
396. I have proposed a gross withholding tax on e-commerce payments (at a general rate of 5%) for above threshold sales. See supra note 171 and accompanying text. It may be more efficient to approximate the impact of a direct net income tax - imposed "directly" on a taxpayer that self-assesses and pays tax on its net income - by using indirect gross taxes. Indirect taxes permit the use of intermediaries to assess relevant taxes on individuals and businesses. Retailers, for example, collect and remit state sales taxes although these taxes are ultimately imposed on consumers. Similarly, a gross withholding tax collected and remitted by an online intermediary could be used to approximate the traditional impact of source country income taxes. This approach would eliminate the need for online companies to calculate income taxes for profits derived in source countries. Under the technological approach previously outlined, the withholding taxes would be collected and remitted without creating undue compliance costs for e-commerce businesses. For thoughts on the need to grant source countries a withholding tax on e-commerce payments, see Cockfield, supra note 11, at 198-205; Doernberg, supra note 23, at 1016-18.
397. For a discussion concerning a call to impose sales taxes only on specified sales into states, see Hellerstein, supra note 179, at 485.
398. See Avi-Yonah, supra note 23, at 532-41.
399. Companies are normally considered to be residents of the country where they are incorporated and thus residency can be achieved by simply filing articles of incorporation.
400. See Avi-Yonah, supra note 189, at 1671. Avi-Yonah's views are in direct opposition to the Treasury Department report, which notes that greater use of residence-based taxation of businesses may be required due to the prevalence of new technologies that make it difficult to tax transactions in the country of consumption. See TREASURY REPORT, supra note 51,¶ 6. The proposed U.S. approach would try to use traditional transfer pricing and cost sharing rules to tax companies when they add value to products. See supra notes 259-70 and accompanying text.
401. See, e.g., J. Clifton Fleming, Jr., Robert J. Peroni, & Stephen E. Shay, Deferral: Consider Ending It, Instead of Expanding It, 86 TAX NOTES 837, 847-50 (2000) (advocating the position that U.S.-based multinational corporations should be taxed on their worldwide earnings on an accrual basis). Under U.S. international tax law, companies are not normally taxed on the generation of active business profits in foreign countries unless, and until, these profits are repatriated back to the United States. Harmful forms of tax competition would be reduced if the foreign affiliates of U.S. companies were forced to pay the same tax burden as the one that was accessed by the U.S. government. The U.S. company would never have a tax incentive to move its business abroad if foreign operations were always subjected to the same burden as domestic operations. This effort would follow the international tax policy principle of capital export neutrality, which maintains that residents should pay the same tax on all business activities, whether or not these business activities take place in foreign jurisdictions. The concern exists, however, that if deferral is eliminated, U.S. companies will not be able to effectively compete against other multinational firms in foreign jurisdictions that impose lower tax burdens.
402. For a more detailed discussion, see generally National Foreign Trade Council, Inc., The NFTC Foreign Income Project: International Tax Policy for the 21st Century, Part One: A Reconsideration of Subpart F, 1999 TAX NOTES TODAY 58-17.
403. See Avi-Yonah, supra note 189, at 1595. Avi-Yonah notes that the tax base would be shared with jurisdictions that produced the goods, as long as they impose taxes that are comparable to jurisdiction of consumption. See id.
404. See Summers, supra note 205.
405. For a criticism of this approach, see generally Stanley I. Katz, International Taxation of Electronic Commerce: Evolution Not Revolution, 52 TAX L. REV. 655 (1997).
406. The current environment of regulatory uncertainty, for example, may be inhibiting e-commerce, as businesses fear multiple layers of taxation should they trade internationally via the Internet. A technology-based mechanism that effectively divides revenues derived from the taxation of an Internet transaction, however, would reduce the risk of double taxation and encourage more trade on the Internet. Further, technology-based solutions might, one day, reduce tax compliance costs for businesses as compliance issues become more automated.
407. For a discussion on sovereignty and tax, see Cockfield, supra note 208, at 49-58. For commentary on sovereignty issues in cyberspace, see generally David G. Post, The "Unsettled Paradox": The Internet, the State, and the Consent of the Governed, 5 IND. J. GLOBAL LEG. STUD. 521 (1998);
408. Shahriar Tavakol, Digital Value Units, Electronic Commerce and International Trade: An Obituary for State Sovereignty Over National Markets, 17 J. MARSHALL J. COMPUTER & INFO. L. 1197 (1999).
409. See, e.g., GLOBAL COOPERATION REPORT, supra note 200, at 5 ("For a global economy to succeed, governments must intensify their co-operation and provide international frameworks for the effective management of global issues. Taxation is no exception.");
410. Henry H. Perritt, Jr., Cyberspace and State Sovereignty, 3 J. INT'L LEGAL STUD. 155, 180-203 (discussing how the Internet can improve the coordination of international institutions).
411. But see David R. Johnson & David G. Post, And How Shall the Net be Governed?: A Meditation on the Relative Virtues of Decentralized, Emergent Law, in COORDINATING THE INTERNET 62, 71-73 (Brian Kahin & James H. Keller eds., 1997) (arguing that international organizations are non-democratic in the sense that they are not held directly accountable to citizens and are subject to unfair influence of privileged factions).
412. See JOHN LOCKE, TWO TREATISES OF GOVERNMENT 348-50 (Peter Laslett ed., 1960) (1690). The only way whereby any one devests himself of his Natural Liberty, and puts on the bonds of Civil Society is by agreeing with other Men to joyn and unite into a Community, for their comfortable, safe, and peaceable living one amongst another, in a secure Enjoyment of their Properties, and a greater Security against any that are not of it . . . . And thus every Man, by consenting with others to make one Body politick under one Government, puts himself under an Obligation to every one of that Society, to submit to the determination of the majority, and to be concluded by it; or else this original Compact, whereby he with others incorporates into one Society, would signifie nothing, and be no Compact, if he be left free, and under no other ties, than he was in before in the State of Nature.
413. Id. For a discussion of Lockean natural rights theory in the context of consumption tax reform efforts, see Arthur J. Cockfield, Income Taxes and Individual Liberty: A Lockean Perspective on Radical Consumption Tax Reform, 46 S.D. L. REV. _ (forthcoming 2000).