Wireless services are probably one of the most widely anticipated e-commerce developments. While small devices and slow network speeds currently limit wireless services, many wireless players are working on designs and strategies to compensate for these limitations. Once wireless services start coming to market, many wireless service providers will have to face the complexities of international taxation that have surfaced for those currently engaged in e-commerce enterprises. Existing commercial e-commerce transactions involving hosting services, data warehousing services, business-to-business (B2B), portal-to-portal (P2P), business-to-consumer (B2C) and other types of exchange services, provision of information and digitized services and digitized ordering are among the types of e-commerce situations that are inherently borderless and encounter international income tax uncertainties. Wireless service providers, and those corporations that undertake international business activities having adopted wireless technologies to improve business processes, could also face increased exposure to income tax in foreign jurisdictions.
This article will address some of the potential international income tax issues for wireless service providers (the mere transmission of telecommunication signals is excluded from our analysis) and their subscribers as seen from a Canadian perspective. Canada, as a member of the OECD, generally adopts the wording of the OECD model tax convention in negotiating its tax treaties with other countries. Whereas our comments may apply in general to other OECD member countries, there are other model tax treaties to which other countries may subscribe. Further, each country has its own unique domestic tax rules that should be consulted. This article focuses on the income tax issues that could arise from wireless services (sales and consumption taxes are not addressed).
We also do not address issues that may face telecommunication service providers. How wireless services are delivered could have a significant effect on the service provider. For example, if telecommunications equipment is located in a country to facilitate the transmission of wireless services, that equipment could create a taxable presence in the country. However, if a third party is engaged to provide the telecommunications service in the local country, one might anticipate that the use of the third party's equipment would be treated consistently with using an independent internet service provider in an e-commerce environment.
BUSINESS APPLICATIONS
Canada taxes non-residents on their sources of income earned from carrying on business in Canada. A multitude of factors are relevant in determining whether a non-resident carries on business in Canada under common law principles, the most important being where the contract is concluded and where the activities of the non-resident are performed. In addition to the common law definition, the Canadian Income Tax Act (Act) contains an extended definition of carrying on business. Under that definition, a non-resident will be considered to carry on business in Canada if it solicits orders or offers anything for sale in Canada, or if it produces, grows, mines, creates, manufactures, fabricates, improves, packs, preserves or constructs, in whole or in part, anything in Canada.
Canada, like many countries, has entered into a series of tax treaties with other countries. These treaties restrict Canada's right to tax residents of that country that have business dealings with Canada. Under these treaties, Canada's right to subject the non-resident to income tax is generally limited to situations in which the non-resident has a permanent establishment (PE) in Canada. A PE can generally be defined as a fixed place through which the business of the non-resident is carried on. The treaties also generally refer to specific activities that create a PE – one such example that leads to a PE in Canada is a dependent agent that has and habitually exercises in Canada an authority to conclude contracts on behalf of the non-resident.
The treaty rules are rooted in the bricks and mortar economy and tend to focus on where activities are physically performed. In an internet, let alone a wireless environment, it may not be entirely clear where an activity is performed. However, at least temporarily, it appears that all e-commerce transactions, including wireless transactions, will continue to be governed under existing treaty provisions. The OECD TAGs have been examining e-commerce transactions in the treaty context, which presumably include wireless e-commerce-type transactions. For now, the OECD has recommended that the current wording of the OECD model treaty is sufficient to govern the taxation of e-commerce transactions without modification. Rather, the OECD is proposing modifications to the commentary to the model treaty to cover e-commerce-type transactions that can be quickly adopted by member countries. Even if the OECD recommended changes to the current PE concept for e-commerce transactions, as a practical matter, it would likely take many years for all tax treaties to be renegotiated to incorporate such changes. The Canadian tax authorities have adopted a "wait and see" approach, looking instead to and participating with the international community in developing appropriate rules and standards rather than attempting to solve the issues unilaterally.
Employees that travel internationally have always generated potential tax exposures for their employers in the countries to which they travel. Advances in wireless technologies and services will serve to heighten these issues. Employees that, in the past, travelled to Canada without creating a Canadian tax exposure for their employer may, once equipped with wireless technologies, create issues for their non-resident employers and non-resident wireless service providers.
The media is replete with examples of potential wireless applications from B2B networks to consumer advertising. The possibilities are so varied it is not possible to generalize about the tax consequences of wireless technology. However, some examples may illuminate some of the traps and pitfalls the unwary may fall into.
PERSONAL DIGITAL ASSISTANTS
Personal digital assistants (PDAs) are increasingly popular handheld computers. Once PDAs are wireless enabled, these devices could help create tax exposures for non-resident employers whose employees travel to Canada. Wireless enabled PDAs could be used to provide field employees with access to much more data, and, as a result, could provide much more latitude and authority to these employees. Although the same could be said for personal computers that are connected through the internet into their company networks, the freedom afforded by these small wireless devices increases the potential number of mobile users that will have real time access to decision making data, and thereby the number of employees that can create a local country tax concern.
Companies are beginning to look to wireless technologies to provide mobile employees with interactive access to information. For example, sales persons could be able to log onto the company's database to check for important details such as credit limits, inventory levels and shipping dates. Such systems could provide an analysis of the customer's history and an electronic approval to proceed based on predetermined guidelines for the customer, with no human intervention required. By accepting an order through a digital signature, the company's system could then process the purchase order, arrange for production and delivery and issue an invoice to a customer's system.
Non-treaty country
If the non-resident is located in a country with which Canada does not have a tax treaty, Canada's taxation of the non-resident will be governed using domestic principles. Canada will tax the non-resident if it is found to be carrying on business in Canada. In determining whether the non-resident is carrying on business in Canada from a common law perspective, Canada would look to where the contract was concluded and whether a Canadian court could assert jurisdiction over the transaction as major determining factors. However, under the extended definition of carrying on business in Canada contained within the Act, Canada would also look to determine whether the non-resident solicited orders or offered anything for sale in Canada.
The threshold for carrying on business is generally considered quite low. As a result, the mere presence of sales persons in Canada representing a resident of a non-treaty country is likely sufficient to cause an issue for the non-resident. Whether or not these employees are wirelessly enabled is unlikely to have a material impact on this outcome.
Treaty country
The analysis becomes more complex where a tax treaty comes into play. In this case, a determination must be made whether the presence of the sales person creates a PE of the non-resident in Canada. Whereas this may have been a relatively simple exercise where formal written approvals evidenced the series of events, it is less than clear when those formal approvals are replaced with wireless communications between the sales person and a database.
A sales person who has the authority to conclude contracts and habitually exercises that authority could create a PE. For these purposes, the Canada Customs and Revenue Agency (CCRA) takes a position that substantial negotiation of the contract in Canada is often sufficient to give rise to a PE. Wirelessly enabling employees to obtain information and electronic approvals could give sales persons wider authority to conclude contracts, creating potential PE exposure whenever they travel to Canada.
BUSINESS ACTIVITIES
Other examples of B2B intelligence have focused on permitting employees to undertake activities while on the road that would normally have to wait until the employee returned to the home office. For example, an employee could electronically receive blueprints for a new product offering and, after reviewing the blueprints, electronically approve the designs. The electronic approval could trigger a series of electronic transactions such as ordering components, booking manufacturing time or concluding customer advance purchase orders for the product. Sales executives may receive up-to-date sales projections and, through interactive data transmission, isolate and remedy problem areas.
The implications of employees undertaking a wide variety of business activities while in foreign countries is not as self evident as those arising from extending sales personnel's authority to conclude contracts. However, wireless technology could have a considerable impact if the employee spends a considerable amount of time in that foreign country.
For example, a recent Canadian tax case dealt with the issue of whether a non-resident consultant that spent 300 days in Canada performing services had a fixed base in Canada. The consultant was working at the premises of a Canadian company providing training to the Canadian company's employees. In concluding the consultant had no fixed base in Canada, the Canadian courts analogized the fixed base concept for individuals to the fixed place of business concept for corporations. The court analyzed whether the consultant could be considered to carry on business through the premises of the Canadian client. In concluding in favour of the taxpayer, the court noted there was ample support that the premises of the Canadian client were not a location through which the consultant carried on his own business. This conclusion was based on findings of fact that the consultant had little or no control over the space made available to him in which he rendered services. The consultant was limited to using the space and telephones made available at the client's premises for purposes of the client's contract only. The consultant took no equipment with him and was not identified in any way as working at the client's premises.
The decision was made based on very specific facts. One has to wonder if the decision would have been different if the consultant had more wireless enabled equipment available to him. What if the consultant had a cell phone on his person at all times that he used on a regular basis to maintain contact with other clients? What if the consultant had a wireless enabled PDA or personal computer that permitted him to maintain contact with his home office and perform or manage services for other clients? With access to wireless technology, it may not be necessary to be identified as being located at a specific location or have access to a telephone at a specific location to effectively carry on business at a location other than the home office.
WIRELESS SERVICES
The media regularly describes new and emerging wireless services such as locating the closest and cheapest gas station while in transit, games and media entertainment, purchasing from vending machines using a cell phone, stock market trading and geographically pinpointed advertising to cell phones. Each one of these services may encompass several "back office" services such as voice recognition and natural language services to interpret what is being requested, a location service to identify location, comparison shopping services, financial services and the wireless service provider.
Users of wireless services may consume these services anywhere, even outside of the home country of the service provider. Wireless service providers could find themselves rendering services in several jurisdictions and will have to be ready to comply with the tax laws of all the countries in which their subscribers may roam.
INCOME TAX
Non-treaty country
Canada will tax the non-resident service provider if it is found to be carrying on business in Canada. Under common law principles, one would normally look to where the services are performed and where the contract to perform those services is entered into. In addition, the Act's extended definition of carrying on business will deem a non-resident to have carried on business in Canada if it solicited orders or offered anything for sale in Canada.
Determining where services are provided in a wireless environment may not be a simple task. For example, if a non-resident facilitates a wireless purchase from a vending machine in Canada, that contract may have been concluded in Canada and the service physically rendered in Canada. It is less clear where related wireless activities have been undertaken such as authentication, verification, payment approval, payment processing, inventory reordering or even where the contract has been made. Will wireless services that appear to be short range (such as advertisements appearing on your wireless device as you approach a participating vendor) be, in fact, carried out from a remote location? Each wireless service transaction and perhaps activity will have to be examined on its own merits and a determination made as to where the service was rendered.
Treaty country
Canada's tax treaties generally require some level of physical presence in Canada by the non-resident before Canada may tax the non-resident. One would need to examine the type of service or transaction that is provided and how the service provider broadcasts its service to determine the physical connection, if any, to Canada. To the extent physical goods are transferred in Canada, as is the case in the vending machine example, a physical connection to Canada and a PE of the non-resident service provider may exist.
Enforcement
A major issue governments will face is the identification and collection of taxes from non-resident wireless service providers. Canada currently has a withholding requirement in place to ensure source deductions are made against payments to non-residents that perform services in Canada. Any person, including a non-resident of Canada, that pays an amount to a non-resident for services rendered in Canada is required to withhold and remit 15% of the payment to the Canadian government. Failure by the payor to comply could lead to significant penalties.
The withholding is refundable to the non-resident service provider if the non-resident service provider files a Canadian tax return and demonstrates that it is not taxable in Canada on these activities. The intention is to ensure that the non-resident files a Canadian tax return disclosing its activities.
Canada has recently tightened up its enforcement of this requirement given the growth of service industries. Whereas exemption waivers from this requirement are available, stringent guidelines are in place requiring significant disclosure by the non-resident to obtain a waiver. To the extent a Canadian resident is the recipient of the wireless services, this withholding requirement will represent a significant identification and collection point for the Canadian government. Although a non-resident that makes payments to another non-resident for services rendered in Canada are also subject to this requirement, the mechanism may prove less effective as the non-resident payor may not be aware of its obligation to withhold.
Withholding tax
To the extent the wireless service provider is not subject to income tax in Canada, consideration should be given to Canada's non-resident withholding tax. Canada subjects certain payments to non-residents (including rents, royalties and similar payments) to a 25% withholding tax. Wireless service providers should review their customer contracts to determine the exact nature of the payment they receive. If the fee is structured as a license, it could attract withholding tax.
Canada's tax treaties generally restrict Canada's right to apply non-resident withholding tax on payments to residents of a treaty country. In addition to reducing the rate of withholding, the treaties often exempt certain types of payments. For example, the Canada-US treaty includes an exclusion for payments for the right to use computer software.
CONCLUSION
Considerable attention is currently being given to how the international tax system should respond to the issues raised by e-commerce. Wireless technologies, as a subset of the bigger e-commerce picture, create an additional layer of uncertainty due in part to the tremendous mobility offered to both the user and provider of the services. The prudent government approach to addressing the wireless issues is to ensure that the e-commerce discussions are broad enough to cope with new technologies and to follow the cautious road of adopting new rules only where necessary.
Jay Niederhoffer is a partner and Mark Briggs is a senior manager in the Toronto office. Email: jniederhoffer@deloitte.ca / mbriggs@deloitte.ca
