1. TAXING OBSCENE PROFITS: Removing Government Incentives for Internet Porn Aldo Forgione, LL.B., LL.M. SJD Candidate, University of Toronto Faculty of Law

2. INTERNET COMMERCE E-commerce involves the purchase and transmission of tangible and intangible goods and services over the Internet Internet allows local vendors to access global markets with relative ease The Internet enables consumers to obtain extensive product information and to better compare competitive products

3. Internet Businesses: The E-commerce Sectors B2B (business-to- business) sector accounts for 80% of global ecommerce Businesses often sell, license and transfer rights and goods to related companies New industries (music piracy and Internet porn) dominate B2C sector Anonymous nature of the Internet has contributed to growth of pornography

4. Canadian Tax Treatment of Global E-commerce Canada Customs and Revenue Agency administers tariffs and taxes at the border for physical goods and collects taxes within Canada E-commerce businesses “resident” in Canada must pay taxes on net global profits (worldwide income – deductions) Canada does not collect income tax on most e- commerce sales made by U.S. businesses

5. Business Contact Threshold A non-resident may be liable for Canadian income tax if the foreign individual or enterprise is deemed by tax authorities to be “carrying on business” in Canada and earns income in Canada The threshold for taxation of business profits changes if the foreigner resides in a tax treaty partner country, such as U.S.

6. Physical Tests in a Digital Age INDIVIDUALS Nonresidents will be subject to taxation of business profits and income from independent services earned in Canada if they maintain a “fixed base” CORPORATIONS A foreign enterprise will be liable for Canadian income tax only if it maintains a “permanent establishment” in Canada

7. The Reverse Foreign Aid Effect of Bilateral Tax Treaties Income from e-commerce sales are effectively exempt from taxation in the country where the sales are completed Bilateral tax treaties change status quo Tax revenues flow from e-commerce importing (usually poor) countries to e-commerce exporters (such as the U.S.)

8. Pitfalls in Taxing E-Commerce Identification difficulties lead to loss of tax system integrity (tax evasion) and practical problems for tax authorities Lack of intermediaries eliminates crucial audit and verification points and the usual collection mechanisms for taxes

9. E-commerce Escapes G.S.T. GST is a consumption tax, but suppliers of taxable goods and services must collect and remit the tax to CCRA Imports into Canada are supposed to be taxed but no effort to pursue ecommerce Goods and services that are exported out of Canada are “zero-rated” (GST exempt)

10. Internet Tax Freedom Internet Tax Freedom Act, 1998 enacted by U.S. Congress to encourage e-commerce Consumption taxes: Tax laws cannot be changed to subject Internet sales to GST, retail sales taxes and other transaction taxes Income tax: Canada effectively allows U.S. and other foreign e-commerce vendors to avoid paying tax to Canada on profits made in Canada

11. Implications of Tax Freedom Loss of revenue – other taxpayers must contribute greater share of “tax pie” Opportunities can be exploited by all without consideration of product/industry Internet technology being driven by music piracy and pornographic demand Violation of tax policy principles

12. Tax Policy Objectives Do Not Support Internet Tax Freedom NEUTRALITY Tax laws should not create artificial biases Transactions should not be taxed differently solely due to the mechanism for delivery of product EQUITY Individuals and businesses in similar situations should be treated equally “Inter-nation equity” infers the fair division of global tax claims

13. Tax Avoidance Strategies Used by E-Commerce Vendors Tax havens and manipulation of tax rules by transferring profits to low-tax nations Transfer prices among related businesses exploit unclear tax treatment of web licenses, software and copyright transfers Vendors adopt entity isolation strategies (shop Walmart.com and save money!)

14. Canadian Implications of Internet Tax Freedom Loss of tax revenues for Canada Competitive disadvantage to Canadian businesses that must impose and collect GST while foreign competitors do not Inequity between consumers that purchase from local outlets and those that shop online without paying GST

15. Emergence of “Internet Porn” Internet merchants enjoy comparative economic, legal and tax advantages U.S. Internet porn industry has grown exponentially Unknown markets

16. Obscene Profits? The supply of information goods and services over the Internet can provide high marginal returns for e-commerce vendors

17. Proliferation of Internet Porn Over 100,000 pornographic web sites Illegal porn refers to obscene materials prohibited under Criminal Code Legal pornography includes lewd or offensive pictures, writings and images Huge resources dedicated to the production of Internet pornography

18. The Crime of Internet Porn Section 163.1 makes it illegal to use Net to “access” child porn In 2002 Ontario man convicted of selling obscene materials over the Internet Economic penalties

19. Benefits Theory and the Taxation of Internet Porn Political factors increasingly correlate a particular tax to particular expenditures The benefits principle of taxation involves considerations of who should contribute to public services and/or social goods Increased government expenditures for the monitoring of the Internet and enforcement of child protection norms

20. Remove Tax Incentives for Internet Porn Level the “playing field” Modify tax rules to apply to e-commerce Develop digital audit procedures that work Ensure Internet porn is subject to taxation like other products Remove Incentives Foreign e-commerce to be treated similar to domestic firms Adopt rules similar to European Union VAT Taxes may affect e- commerce growth

21. Predictive Impact of Taxing Internet Porn SUPPLY SIDE Additional tax, administrative and compliance costs for Internet merchants will reduce the supply of pornography and shift the supply curve DEMAND SIDE Equal application of tax will lead to higher prices for Internet buyers, thereby, eliminating online price advantage and placing downward pressure on demand

22. Taxation and the Economics of Internet Pornography The movement of the demand and supply curves—and the resultant pricing system– will depend on the elasticity of the demand and supply functions within the Internet porn market Some private porn transactions will be curtailed by the imposition of government regulation Satisfaction of government revenue objectives will be influenced by relative elasticity –or inelasticity-- of supply and demand over time

23. Future Prospects of E-Commerce Taxation E-commerce can be encouraged through the use of targeted tax incentives Benefits principle of taxation could be invoked to extend special user fees and tax levies (like fuel taxes) to pornography Taxation: An alternative to censorship?