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United States Taxation of Foreign Electronic Commerce


United State taxation of electronic commerce from offshore is to be approached from two perspectives, the United States tax regime from an international perspective and bi-lateral treaties. This writing addresses the first consideration, the tax regime. As stated in a previous segment, international sourced based taxation poses particularly difficult legal risks. (1)

One risk is the electronic commerce and taxation implications. Those issues grapple with electronic commerce and taxation implications when melded with the notion of jurisdiction. Cross-border taxation issues of the authority of a source and resident country engage the application of the concepts of the Commerce Clause and Due Process. (2)

The foundation of the concepts of the applicable nexus for taxation embraced the evolution of domestic cases that have evolved from the required nexus being a physical presence coupled with other factors to the nebulous view of an economic presence. (3) The establishment of this foundation is premised upon domestic application. Case law taxation analysis that addresses sale, use, and income tax are essential in understanding the application of the United States tax regime to foreign electronic commerce.

Concept of Source

Contrary to the outbound transaction concept that citizens and residents (4) of the United States are subject to United States taxation with respect to their worldwide income, entry taxation or inbound taxation concerns the concept of source of income. In the most general of terms, the taxation liability of nonresidents is premised on jurisdictional notions.

Income of nonresident aliens (5) and foreign corporations determined to be from sources within the United States is subject to United States taxation. (6) The term source is not defined by statutory provision or regulation and is intended to function as a guideline in the determination of what income will be subjected to taxation.

Additionally, it is a concept used to differentiate income deemed to be foreign sourced and therefore accorded certain foreign tax credit preferences. United States tax policy claims a share of all incomes generated by its people and also that of taxpayers generating income deemed sourced in the United States. Two basic principles establish jurisdictional tax liability with regard to income deemed sourced from within the United States. Nonresident aliens and foreign corporations become subject to tax jurisdiction by having a presence in the United States through the active conduct of a trade or business (7) or by United States statutory income source authority. (8)

The source concept is applicable to all taxpayers whether they are individuals, corporations, partnerships, trusts, estates, branches, or other entity forms. The conceptual notion of source of income embraces the consideration of capital that generates the income as well as the combination of labor. General theory with respect to the statutory scheme of source of income recognizes that income from property is normally sourced at the location of the assets producing the income. On the other hand, income generated from services is generally perceived as sourced where the services are carried out and performed. (9)

Linkage of Trade and Business and Effectively Connected

A foreign corporation is required to be deemed engaged in a trade or business in the United States and its income effectively connected to be taxable. Though the treasury regulations do not elaborate further as to definition of trade or business other Code provisions have defined the term. (10) Case law also plays a defining role in understanding the degree of activities which engage the breadth of the term. The thread that appears common among factual contexts is the regularity of activities and transactions involving more than passive characteristics. (11) This unlike the state by state guidelines is the federal taxation nexus.

Secondly taxation of Section 882 of the Code requires in addition to being engaged in a trade or business, income determined as effectively connected with the conduct of a trade or business. The concept of effectively connected is applicable to nonresident alien individuals or foreign corporations engaged in a trade or business in the United States. The trade or business must occur at some point during the taxable year and income realized from United States sources. (12) When both elements, effectively connected and engaged in a trade or business are present, taxation is to be sourced in the United States. The applicable individual or corporate rates apply.

The decoupling of effectively connected income by a foreign corporation from a United States trade or business status subjects the taxpayer to a flat rate tax of thirty percent. (13) As an alternative to the flat rate of thirty percent, a taxpayer can avail itself of preferable treaty rate. In making an evaluation of whether the structure of financial planning should be designed as effectively connected income or an alternate treaty rate, the guiding rule is that a flat rate is imposed upon gross income without any allowance for any deductions. (14)

Electronic Commerce and Trade or Business

The statutory language that sources income from within the United States sets as the premise that there must be an active trade or business in the United States from which a nonresident alien individual derives the income. (15) The income is to be treated as effectively connected with the conduct of a trade or business in the United States whether or not the income is derived from the trade or business being carried on in the United States. (16) All income from United States sources is treated as effectively connected with the conduct of the foreign person’s United States business. Source is a presence in the United States through the active conduct of a trade or business or by specific statutory authority. (17) Source along with term the active conduct of a trade or business has no definitive definition accompanying it in the Code. The fact is that payment by one within the United States to a foreign party does not determine the source of income to be inclusive to the United States. (18)

The real significance of that fact is that one contemplating whether a foreign person is conducting electronic transactions in the ordinary course of business is that it requires that the income be deemed sourced in the United States and that there be an active trade or business. That business is conducted with a United States person is not determinative of whether a trade or business is conducted in the United States; presence and a degree of activity are the requisites.

Presence as has been discussed has evolved from a required physical presence to an economic presence with respect to domestic case law, both as to jurisdiction and taxation. (19) An activity has a situs or location. The situs determines the source of income. Whether a foreign corporation has an office of place of business within the United States depends upon the facts and does not include a place where casual or incidental transactions might be effected. The source is not a place, it is an activity or property. It has a situs or location. If that situs or location is within the United States the resulting income is taxable to nonresident aliens and foreign corporations. Whether income from sources within the United States received by a foreign corporation that is organized and exists under the laws of a foreign sovereign is the question. (20)

Defined as a presence in the United States by virtue of the active conduct of a trade or business, source requires ascertaining what is a presence in these evolving times. The foundational case of Piedras Negras Broadcasting Co. v. Comr. (21) provided a similarity of issues that arise in electronic commerce. It arose prior to the Internet, but it was very clear in its primary assertion that situs determines the source of income. Core activity of a foreign corporation has a situs or location and that situs is definitive of the source of income. This case provided an analogy to the Internet that facilitates electronic commerce; it broadcasted radio frequency advertisement into the United States from Mexico.

Perhaps of most importance was that in Piedras Negras Broadcasting Co. the court cited an interstate commerce case that dealt with nexus requirements of a state to tax. Its reference of the case was to establish that mere broadcasting through the air over a state did not establish an appropriate nexus for imposition of United States tax of a foreign person. It looked to the original source of the transmission of the messages, not the secondary activities of the transmission received.

Of importance is the court’s discussion of activities that constitute conducting a United States trade or business for purposes of United States taxation upon a foreign person. The nexus aspect was discussed in the same fashion as out of state conduct that has been the subject of interstate commerce. In that vein, the nexus of similarity was discussed from a point of reference that a certain amount of physical presence within the jurisdiction was necessary. The physical presence required pertained to the core activity as Piedras Negras Broadcasting Co. stated, core activity has a situs and situs is determinative of the source of income. The evolution of physical presence has obviously progressed to acceptance of economic presence that could have a direct bearing on the premise of the Piedras Negas Broadcasting Co. analysis.

Going forward it is seemingly mandatory to anticipate that physical presence will become the concept of economic presence from a planning perspective. As with the similarity of jurisprudence regarding the interchangeability of nexus concepts of taxation and judicial jurisdiction, (22) it will be necessary in this forward thinking to adjust to the concepts presented in judicial jurisdiction evolution. But first a foundation of the judicial framing of what has been required for the determination of engaging in a United States trade or business that subjects sourced income to United States taxation is needed.

Trade or Business

For income to be deemed sourced in the United States, there must be an active trade or business. Foreign persons must have certain minimal contacts with the United States with respect to their United States business activities to be subject to United States taxation jurisdiction. Judicial interpretation has set the contours and the characteristics of activities transpiring in the United States that satisfies that threshold. The threshold of activities that rise to the level of engaging in business are consistent with being substantial and taking place with a degree of frequency in the United States. That has been established as sustaining the basis that a United States trade or business exists. (23)

If the facts establish that a foreign person is engaged in a United States trade or business, the person is subject to United States income tax on net income that is effectively connected with that trade or business. All income that is determined to be from United States sources’ is treated as connected with the conduct of the foreign person’s United States trade or business. (24)

Cyberspace and Presence

Minimum contacts with the United States taxing jurisdiction does have inter-connecting concepts with the analogy of Due Process and the Commerce Clause. (25) The presence requirements for the threshold minimum of conducting a trade or business in the United States were much more pronounced in jurisprudence prior to the focus upon the dormant influence of the Commerce Clause upon the domestic state taxation controversies.

Since Piedras Negras Broadcasting Co. (26) that addressed reliance on interstate commerce cases as to location, electronic commerce business has evolved. The physical presence in domestic cases has trended to the economic presence but has not been discussed in the requisite taxation nexus of the Internet in the manner of judicial jurisdiction. The similarity of jurisprudence suggests that looking to the jurisdiction evolution with respect to web servers will allow for the best insight to the taxation by the United States of electronic commerce of foreign persons.

With the advent of electronic technology of the Internet and commercial activity generated by Website Commerce, the application of previous precedents to an assertion of in personam jurisdiction of non-resident defendants has necessitated an adaptation. This new horizon of the Internet and electronic commerce has presented the question of what the breath is that establishes the type of Internet contact that can be deemed sufficient to exert personal jurisdiction upon a foreign defendant.

Initially a very bold concept evolved that advanced the notion of jurisdiction being appropriate upon the mere presence of a Website that could be accessed in a forum of the plaintiff by an Internet source. The court exerted in personam jurisdiction upon the defendant premised upon the fact that there was only the presence of a Website that was owned and maintained by the defendant and that plaintiff was able to access it by the Internet. (27)

This same approach was adopted in the United States District Court of California. Their exertion of general jurisdiction was rejected, but the limited scope of specific jurisdiction extended pursuant to a three-prong test that evaluated the nature and quality of contacts requisite to assertion of limited jurisdiction. It reviewed whether the defendant had purposefully availed itself of the jurisdiction, thus availing itself of the protections and benefits of its laws, that the claim arose from forum related activity, and that the assertion of jurisdiction was reasonable. The language of protections and benefits of the states laws embraced in the analysis is quite similar to recent nexus analysis where states have grounded their reasoning to tax in similar theory.

The foreseeability of defendants’ action to be answerable for the veracity and propriety of their action was critical to the due process analysis. The factual notation of the court was that the use of computers makes a message available not only to the recipient, but also any other party that has Internet access. For that reason the court explained a need to therefore broaden the permissible scope of jurisdiction exercisable by courts. (28)

A third case that grappled with the early issues of in personam jurisdiction and the Internet was in a United States District Court in Virginia. To address the issue of doing business or soliciting business as stipulated in the long-arm state statute, the court concluded that posting a Website advertisement constituted a persistent course of conduct that rises to the level of regularly doing or soliciting business. Because the defendant advertised and solicited over the Internet and it was accessible by a Virginia resident 24 hours a day, it met the standard of the long-arm statute of doing so regularly. The court additionally reasoned that defendants’ activities were sufficient as an analogue for physical presence. (29) It just would not be prudent to not incorporate these court decisions into ones planning that there is the possibility to find a nexus of presence to tax based on similar logic.

Courts seemed to feel the need to gravitate toward a three level perspective as it evolved in this weighing of due process. The term sliding scale came into play in an important judicial analysis and subsequent court decisions were very much swayed by the flexibility. (30) The sliding scale developed in that opinion became a flexible guidance to the judiciary that sought not to apply broad reaching jurisdiction that was flavored with an exorbitant expansion.

Website interactivity was deemed to be comprised of three areas, the passive Website, the commercial Website, and the interactive. (31) Utilizing this scale, a passive Website is depicted as one that provides information to an Internet user and does not provide any additional presence in the jurisdiction. This is the move away from the concept that mere Website accessible by any Internet user worldwide could bestow presence and personal jurisdiction requisites. (32) It is an accepted principle that Website presence is a significant contact with the forum. However that quality and quantity of contact is not viewed by most judicial interpretations to be sufficient alone to exert personal jurisdiction over a foreign defendant when the Internet is the only contact. (33) It is important to note that quantity and quality are similar terms applied as jurisprudence in established tax nexus analysis mainstay premised cases.

A second type of Website, one deemed commercial in nature, is seemingly defined by the characteristics that it seeks to complete a volume of transactional business over the Internet. Its design is to accommodate a quantity of transactions. This would embrace Website activity that is perceived as doing business over the Internet, such as making of contracts with residents of a foreign jurisdiction. This would be demonstrated when a party repeatedly is engaged in the transmission of computer files over the Internet. (34)

The other area characterized in this Zippo Doctrine is the Website that can be deemed interactive; not passive and not commercial. Those involve interaction that is something more than static advertising or production information and less than a complete transactional business Website. The interactive Website may or may not provide sufficient contacts to provide a jurisdiction basis; these are Websites that enable a user to exchange information with the host computer. The level of interactivity coupled with the commercial nature of the exchange is the flexibility of interpretation that provided the judiciary latitude to step away from the inclusive exertion by virtue of the passive Website. (35)

The heightened standard of general jurisdiction has been met in domestic Internet commerce. It is quite a progressive concept based upon a Website’s cumulative contacts becoming the equivalent of a physical store and the interpretation of the Zippo Doctrine framework not requiring actual presence in a state. It is based upon the notion that even if the contacts are established by defendant’s virtual store, a finding of general jurisdiction is consistent with the doctrine framework.

When a defendant has deliberately and purposefully availed itself, on a large scale, of doing business within the state it has been held to meet the classic criteria of the Zippo Doctrine. That is it becomes a showing of clearly conducting business over the Internet and the Internet business contacts with the forum state are deemed substantial or continuous and systematic. This conclusion has been decisive when there is a showing that the nature of the commercial activity is substantial to the extent that it approximates physical presence. (36)

1. See TaxConnections, Due Process and Regulation of Commerce – Offshore Financial Centers Cross Border Taxation, June 3, 2014, William L. Richards.
2. See TaxConections, The Commerce Clause – Due Process and Cross Border Taxation, June 11, 2014, William L. Richards.
3. See TaxConnections, Evolution of Tax Principles – Jurisdiction and Nexus of Electronic Commerce, July 14, 2014, William L. Richards.
4. IRC Section 7701 (a)(1)(30) (1986).
5. Treas. Reg. Section 1.871-(a) of the IRC of 1986.
6. Id. at 5.
7. IRC Section 861 (1986).
8. Treas. Reg. Section 1.864-2 of the IRC of 1986 and as thereafter amended. Also see Treas. Reg. Section 1.861-1(a) of the IRC of 1986. The term engaged in trade or business within the United States … does not include the performance of personal services …for a nonresident alien individual … or foreign corporation not engaged in trade or business within the United States at any time during the taxable year.
9. Eisner v. Macomber, 252 U.S. 189 (1920).
10. IRC Section 162 (1986).
11. Pinchot v. Comm., 113 F.2d 718 (1940). Whether or not it was engaging in business within the meaning of federal tax statutes is a federal question that cannot be controlled by state decisions. This involved management of real estate for income producing purposes requiring regular and continuous activity and many other things which came within the definition of business. See also The Linen Thread Co. v. Comm., 14 T.C. 725 (1950). There the degree of regular, continuous and substantial United States activity, along with a physical presence provided the necessary connection.
12. IRC Section 864(c) 1986. See Treas. Reg. Section 1.864-5 of the IRC of 1986.
13. Treas. Reg. Section 1.881-1(b)(1) of the IRC of 1986.
14. Treas. Reg. Section 1.881-2(a)(3) of the IRC of 1986.
15. Treas. Reg. Section 1.864-4(b) of the IRC of 1986.
16. See, IRC Sections 871-872 (individuals) and IRC Section 881-882 (corporations).
17. Treas. Reg. Section 1.861-1 of the IRC of 1986.
18. Nicholas Roerich, 38. B.T.A. 567, aff d, 115 F2d 39 (1940). The mere receipt of income from payor within the United States does not determine the amounts received to be income within the United States, Piedras Negras Broadcasting Co. v. Comr., 43 B. T. A. 297 (1941), aff’d 127 F.2d 260 (Cir. 1942).
19. See TaxConnections, Evolution of Tax Principles – Jurisdiction and Nexus of Electronic Commerce, July 14, 2014, William L. Richards.
20. Piedras Negras Broadcasting Co. v. Comr., 43 B.T.A. 297 (1941), aff’d 127 F.2d 260 (5th Cir. 1942).
21 Id. at 20.
22. Supra at note 3, Jurisdiction – Nexus – Electronic Commerce.
23. Continental Trading, Inc. v. Commr., 265 F.2d 40 (9th Cir. 1959). In this case the U.S. Tax Court concluded from the facts that the contacts were isolated and noncontinuous and that incidental transaction in the United States did not rise to the level of engaging in United States trade or business. See Treas. Reg. Section 1.864-7(d) of the IRC.
24. IRC Section 864(c)(3) of 1986.
25. Supra at note 19.
26. Supra at note 20.
27. Millennium Enterprises v. Millennium Music, LP, 33 F. Supp. 2d. 907 (U.S. District Court Oregon (1999).
28. Inset Systems, Inc. v. Instruction Set, Inc. 937 F. Supp. 161 (D. Conn. 1996). “… The essence of the minimum contacts test is “that there some act by which the defendant purposely avails itself of the privilege of conducting activities within the forum State, thus invoking the benefits and protections of its laws.”…”. “… This “due process inquiry rests upon the totality of the circumstances rather than any mechanical criteria …”
29. Telco Communications v. An Apple A Day, 977 F.Supp. 404 (U.S. D. C. E.D. Virginia 1997).
30. Zippo Manufacturing Co. v. Zippo Dot Com, Inc. 952 F. Supp. 1119 (U.S. District Court W. D. Pa. 1997).
31. Id. at 30.
32. Supra. at 28.
33. Arthur F. Sawtelle v. George E. Farrell, 70 F.3rd 1381 (1995).
34. Supra at note 30.
35. Supra at note 30.
36. Corp. v. LL Bean, Inc., 341 F.3d 1072 ( 9th Cir. 2003).


William Richards is a Sole Practitioner in Orlando, Florida, USA 32626. Attorney at Law, Legal Advisor. 1978 – Present

PUBLICATIONS: International Financial Centers, Adell Financial Series, AD Adell Publishing, Copyright 2012, 378 pages. The Handbook of Offshore Financial Centers, Adell Financial Series, AD Adell Publishing, Copyright 2004, 266 pages; Offshore Financial Centers and Tax Havens, Archives of Tulane Law Library, Tulane Law School, Tulane University, New Orleans, Louisiana, Copyright, 1996, 512 Pages.