Sixty-Year-Old Case May Set Precedent
Case affects internet and international tax planning

By Richard S. Lehman, Esq., of Richard S. Lehman P.A.; Boca Raton, FL
Published: October 4, 2000
South Florida’s The Sun-Sentinel Boca Raton Business News

In today’s “Internet Age”, where there seems to be a contempt and questioning of some of the old rules of business, it’s somewhat ironic that tax planning today for activities in cyberspace may be tied to a case that is almost 60 years old.

There is no question that the Internet and “e-commerce” are re-defining how, where, and with whom we do business. The World Wide Web has opened up new markets by allowing us to effortlessly cross borders, an opportunity that smaller businesses never had.

It has enabled us to sell product and services 24-hours a day. And, we’re able to transmit photos, documents, and other data in seconds.

Yes, it is truly a new world. But, regardless of what this dynamic medium has provided in the way of opportunities, there is still one age-old issue to address - The Taxman Cometh. Unless, as always, we prepare.

As far as the Internal Revenue Service is concerned, little has changed in this Internet Age. Profits will be made and income taxes will be made and income taxes will be charged. As has always been the case, taxes can be minimized with proper planning. This is particularly so regarding e-commerce that has international aspects.

The unique way that e-commerce takes place makes it difficult to apply familiar international tax rules and concepts to Internet-based transactions. Existing tax rules do not make clear (1) the nature of the transaction where electronically delivered products are involved; (2) the source of the sales income; or (3) the location at which title to the digitally-delivered property changes hands.

For instance, taxation in the United States depends on the residence of the taxpayer and the source of the taxpayer’s income.

The Internet makes the determination of both of these difficult. For Internet based companies, tax rules that depend on the location of both buyers and sellers are hard to apply in the borderless environs of cyberspace, where a change in the Internet business location is so easily accomplished.

At this early stage in the development of e-commerce, there is little historical precedent in tax law for determining the source of income from many types of Internet-related income. Although there are no existing cases that specifically consider Internet earnings, there is some guidance from the past in a case known as Piedras Negras Broadcasting Co. vs. The Commissioner of Internal Revenue. In this case, a foreign corporation, having no office or fixed place of business in the United States, executed and initiated radio contacts from its foreign office in Mexico and broadcast programs into Texas designed for U.S. listeners and supported by U.S. advertisers. Piedras Negras received almost all of its gross income from United States persons.

It clearly establishes that the mere receipt of income from persons located in the United States does not determine that the income is earned within the United States. The point of differentiation is that the business was conducted in Mexico and that the economic functions that led to the income were conducted in Mexico.

The 59-year-old decision states: “It (the source of income) is not a place, it is an activity or property . . . if that site or location is within the United States, the resulting income is taxable to nonresident aliens and foreign corporations . . . Thus, if an income be taxed, the recipient thereof must have a domicile within the jurisdiction . . . Broadcasting is accomplished by the generation, at the broadcasting station, of electro-magnetic waves which pass through space . . . When we speak of wavelengths or frequencies, we are dealing with intangible things.

“It thus appears that broadcasting through the ether does not in any ordinary sense cause contact or interaction between properties of different owners, such as transactions of business usually entail, and that the foreign broadcasting corporation here cannot be said to be using property in the United States. The transmission of the impulse through the ether over the United States and reception at receiving sets therein seem to be intermediate steps in the process and not the source.”

While there are differences between the technologies involved with transmitting information via radio frequencies and the Internet and no one case will answer all of the open tax issues, it is apparent that there are tax planning opportunities in international e-commerce that the U.S. business person needs to explore.

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Richard S. Lehman

* Georgetown University J.D.
* New York University L.L.M. Tax
* Law Clerk to the Honorable William M. Fay – U.S. Tax Court
* Senior Attorney, Interpretive Division, Chief Counsel’s office, Internal Revenue Service
* Author: “Federal Estate Taxation of Non-Resident Aliens,” Florida Bar Journal
* Contributing Author and Editor: International Business and Investment Opportunities” Florida Department of Commerce, Division of Economic Development, Bureau of International Development (translated in German, Spanish, and Japanese)