Internet Companies May be Circumventing Tax Rules

The IRS has been charged with the responsibility of determining the effect that an Internet presence has on the administration and compliance rules relating to the collection of income tax.

As part of that effort, the upstate New York IRS district office conducted a research project that confirmed the concerns of the Treasury Department, that companies operating on the Internet may not be paying their full share of income tax.

The study covered six distinct market segments, all identified through 18,000 Web sites delivering goods or services. These included Internet access and service providers, computer sales and services, financial services, business services, retail and wholesale businesses, and adult entertainment.

Nine percent of these sites were examined for the study, and 426 businesses that were active in 1997 were audited as part of the project. Survey designers pointed out that although 1997 was the year chosen for the study, they understand that the speed of the Internet has dramatically increased the number of sites on today's Web, and they have factored this into the study.

Now the findings:

  1. The tax gap, or the difference between the amount of income tax owed by companies conducting business over the Internet and the amount collected from these companies, is estimated to be $6.2 million.

  2. Identifying and ensuring all businesses will pay tax is difficult - 12 percent of 1,600 sites were not found on IRS tax rolls and five percent of these were inactive sites within the first 45 days of business.

  3. Unreported income is a big problem - 10 percent of the sample did not even file tax returns in 1997. In addition, 30 percent of sites understated their income.

  4. The proper tax treatment of personnel costs related to developing a Web site still being debated.

  5. In a world without geographic borders, rules for tax compliance become more complicated. Verification of foreign ownership of sites was not possible.

Concerns of the Treasury Department as a result of the study include:

  • Voluntary tax compliance may become harder to enforce as companies can manipulate residency and bypass tax checkpoints such as wholesalers.

  • At present there is no official IRS registration process for Web sites, thus increasing the possibility of noncompliance.

  • On the plus side, Internet companies seem more focused on increasing income than on strategically avoiding taxes.

  • The difficulty of tracking the electronic transfer of money over the Internet poses concerns about voluntary compliance.
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