Most tax laws applying to e-commerce are still based on the traditional way of doing business, where the focus is on a company's geographic presence and the physical delivery of goods and services.

It is clear, however, that these laws do not adequately translate to transactions done in cyberspace. And just what kinds of laws would work effectively for this relatively new mode of business have yet to be determined.

At this point, the extraordinary growth of e-commerce in the past few years and its expected future growth to $1.3 trillion in 2003 have lawmakers playing catch-up in their attempt to define and enforce a taxation structure specifically for the Internet.

The Internet Tax Freedom Act, or ITFA, passed in October 1998 put a three-year moratorium on new taxes on Internet access fees, and on new state taxes that are discriminatory or result in multiple taxation. The act also led to the formation of the National Advisory Commission on Electronic Commerce.

The commission is charged with recommending to Congress what, if any, future taxes should be allowed on Internet access or sales.

The challenge is to find a tax basis for the Internet that doesn't impede e-commerce. While the commission was expected to provide its recommendations to Congress no later than next month, it adjourned last week without reaching an agreement. That doesn't mean e-companies should wait to start their cybertax planning. There are several proactive measures that companies can take to prepare for possible regulations.

-Be aware of the administrative burden of cybertax liabilities. At this point, existing taxing jurisdictions can require your company to file up to 6,500 different tax forms in the United States alone. Internationally, over 200 countries impose direct and indirect taxes. If you have customers in multiple states and countries, what you don't know could hurt your business.

-Realize that all Internet transactions are not tax-free. Despite the ITFA moratorium, a grandfather provision allows states that imposed taxes on Internet access before October 1998 to continue to collect those taxes.

If your company has a physical presence in one of those states, you could have to collect sales and use taxes from your online customers. So you need to know your "nexus" and "permanent establishment."

Nexus is the degree of business activity or physical presence required before a state or local tax jurisdiction can tax a business or require it to collect tax. Each state has its own set of rules for nexus, which can be determined based on where your e-business server resides or where the fulfillment company is located.

Permanent establishment is the standard many countries use to determine taxing jurisdiction. So to avoid being ensnared in unnecessary tax liabilities, establish operations in cybertax-friendly states like California or New York, or in states without a sales tax, such as Oregon and Delaware.

(E-business tax-friendly countries include the United States, the Netherlands, Singapore and Bermuda.)

-Find out whether tax credits are available. Many countries and states offer a wide variety of tax credits, tax holidays and other incentives designed to encourage e-businesses to locate there. While some of these incentives are defined by statute and available to all companies, many are negotiable.

Ask about potential tax credits and incentives before you finalize your location selection.

-Explore tax implications ahead of time. Consider the tax implications of your e-business strategy before you begin the design and implementation phases. Often times, relatively minor operational changes or modifications to contractual terms can dramatically impact the taxation requirements of your firm.

-Make your Web sites extra smart. Build tax information and tax collection fields into your smart Web sites (those that send information back and forth on inventory availability, etc.), but don't activate them yet.

If you prepare now, you'll be ready to use those fields if and when the time comes. Ultimately, this pre-planning may save your company millions in redesign costs.

-Consider record retention policies and "audit trails." Tax authorities generally require that records, including electronic records, be retained for periods ranging from three to seven years. In addition, many international tax authorities still require paper documents with original signatures.

Make sure your company understands and can comply with these requirements before tax authorities perform an audit.

-Plan ahead for global expansion. Prepare for international tax liabilities, including customs duties and value-added taxes, and be sure to account for the costs of managing the legal and financial requirements. In addition, know the tax treaties and what types of transactions will require tax returns to be filed in foreign countries.

Like states, each country has its own tax laws and filing requirements. Consider whether the international revenues justify the tax and administrative expense.

Obviously, it can pay to prepare today for taxing tomorrow. So make sure to investigate the long-term cybertax plans for the states and countries where your server and business partners are located, as some states are more cybertax-friendly than others.

Also remember the Internet Tax Freedom Act will expire. Taking these proactive steps now can put companies in a better position to comply with the tax laws that could prevail after the commission's work is done, whether they are favorable or not.

Scot Grierson is a director of multi-state tax services for Deloitte & Touche. He can be contacted at

Entrepreneur's Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1759 with feedback and topic suggestions.

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