International Journal of Law and Information Technology, Vol. 9 No.

1
Oxford University Press 2001

The Regulation of
Electronic Commerce:
A Comparative Analysis of
the Issues Surrounding the
Principles of Establishment
JAMES CATCHPOLE1

1.

Introduction

It is without doubt that the Internet became one of the most important
commercial mediums to emerge in the latter years of the 20th century. Its
continued growth will, in part, be reliant upon the ability of regulating
authorities and jurisdictions to embrace, and control, the activities for
which it will be used.
The consensus of regional, national and supranational bodies is that
e-commerce should be embraced as an integral part of business and,
therefore, regulated and controlled to afford consumers, and alike, the
legislative protections that are available in the physical world. However, the
Internet, by its very nature, has shown itself as a respecter of neither
geographic nor jurisdictional boundaries and has challenged national and
regional laws in ways that could not have been envisaged a decade ago. It
has become evident that it will be necessary to precisely determine where

1
LL.M. This paper is based on the authors LL.M dissertation submitted in June 2000. The views
expressed in this paper are the authors own and the law as stated in June 2000. The author is now a Solicitor
with Landwell UK, a correspondent Law firm of PricewaterhouseCoopers.

THE REGULATION OF ELECTRONIC COMMERCE

certain Internet and e-commerce activities take place in order that such
regulatory controls are effectively exerted.
The concept of establishment has become one means, possibly a defining
factor, by which this certainty and the difficulty in determining jurisdictional control may be obtained. But, establishment is yet another area that
is struggling in its application to the on-line world. This paper will consider
why it is important to implement regulatory controls, examine the concept
of establishment and its application to e-commerce.

2.

The Importance and Regulation of

Electronic Commerce

Most policy documents that have been, and are currently being, produced
by various organisations, as a consequence of the Internets proliferation
and the phenomenal growth of electronic commerce, invariably state their
aims as:
. . . to encourage the vigorous growth of electronic commerce [in Europe]. 2
Electronic commerce, or e-commerce, is a term that has become synonymous
with commercial transactions involving both organisations and individuals,
based upon the processing and transmission of digitised data, including
text, sound, and visual images, transmitted over open networks such as the
Internet.
Since its inception in the mid-1990s, the global electronic marketplace
has grown at an exponential rate and is assuming greater importance in
everyday commercial activities. The European Commission has suggested
that the challenge is to promote the widespread adoption of e-commerce
as an integral part of the way in which business is performed.3 A sentiment
that business appears to be adopting.
E-commerces profile is enhanced still further by optimistic predictions
suggesting that the worlds online consumers will exceed 300 million
persons, contributing over $3.2 trillion to global sales, by the year 2003.4
The Federal Trade Commission in the United States reported that the total
online retail sales for 1999 in the United States amounted to between
$20$33 billion and consumers shopping online exceeded 60 million.5
Thus, there can be no doubt that e-commerce has assumed an importance
2
European Commission, A European Initiative in Electronic Commerce (Green Paper), COM(97) 157 15 April
1997.
3
Ibid., para. 3.
4
WF Fox, International Electronic Commerce, American Law Institute, 12 July 1999.
5
Privacy Online: Fair Information Practices in the Electronic Marketplace, A Report to Congress, Federal Trade
Commission, May 2000, at 2.

JAMES CATCHPOLE

of significant proportions in relation to future world trade a claim that

may be supported by the fact that the World Trade Organisation has stated
that e-commerce now falls within the ambit of the General Agreement on
Tariffs and Trade.6
Unsurprisingly, an increasing number of organisations are turning their
attention to address the need for regulation of certain Internet and
e-commerce activities to ensure that the off-line world regulations are also
capable of application to the on-line world. As with other commercial
mediums, it is recognised that, in order to build consumer confidence and
establish a more balanced relationship between business and consumers, it
will be necessary for consumer laws, policies and practices limiting
fraudulent, misleading and unfair commercial conduct to be applied in
order that a transparent and predictable legal and self-regulatory framework is created for e-commerce.7 However, the desire to regulate swings
between the emotions of unwarranted interference in an nascent market
place said to be developing at its own pace,8 and the need to give credibility
to any measure introduced to both promote a medium that is bringing
social and economic benefits and, to prevent it being subjected to abuse
that may damage its development.
Discussions have concentrated upon generic issues, namely, regulation
of e-commerce generally, taxation, contract formation and execution,
consumer protection, privacy, market access, including issues of competition law, intellectual property, and content regulation. However, the
Internets international nature and use of digital networks and computer
technologies challenges both countries and jurisdictions abilities to
adequately address such issues and risks the introduction of disparate
national policies that may impede e-commerces growth. For example, the
EUs and the United States varying concepts of data protection and
privacy raised the spectre of data embargoes between the regions following
the implementation of the EUs Directive on the Protection of Individuals with
Regards to the Processing of Personal Data and on the Free Movement of Such Data.9
This was a direct consequence of the prohibition imposed by Article 25 on
the transmission of personal data to non-EU Member States without
adequate levels of protection. Whilst the Safe Harbor principles have been
agreed, until these regions either agree a compromise in respect of
transborder data transfers specifically applicable to the internet, or the
United States long-standing reliance upon private sector self-regulation is
replaced with data protection legislation comparable to the EUs, serious
6

Fox, supra.
OECD, Recommendation of the OECD Council Concerning Guidelines for Consumer Protection in the Context of
Electronic Commerce, at 1.
8
New York Times, US is Said to Seek New Law to Bolster Internet Privacy, 19 May 2000, and White House & Agency
Split on Internet Privacy, 22 May 2000.
9
Directive 95/46/EC of the European Parliament and of the Council of 24 October 1995, OJL 281/31,
23 November 1995.
7

THE REGULATION OF ELECTRONIC COMMERCE

anomalies in these regions regulations still threaten the operation of the

Internets efficient routing of information.10
Whilst there is an undoubted need for a consensus in the formulation of
a global approach to the Internet and e-commerce, so as to ensure that
regulatory frameworks operate within workable competition policies and
that the market is not restricted, those commercial activities that are
already regulated are regulated upon notions of jurisdictional control
within geographical limits predating the Internet or e-commerce. As issues
of data protection illustrate, the Internets own operation challenges such
controls, in most part due to the question of enforceability as the Internet is
unrestrained by geographic borders and, therefore, existing jurisdictions
have reduced meanings (though that is not necessarily to say that
jurisdiction over activities within boundaries is lost) affording e-commerce
operators the opportunity to circumvent jurisdictions with less favourable
regimes. Therefore, the key must be to implement framework principles
with sufficient detail to allow e-commerce to operate in an environment of
legal certainty while not depriving local jurisdictions of the ability to
enforce local values through their own laws.

3.

Electronic Commerce and the Permanent

Establishment Concept

As may be envisaged, those regional authorities and national governments

encouraging e-commerces development also acknowledge the benefits
derived from e-commerces commercial growth. The obvious must be
stated at this juncture: regional authorities and national governments,
whilst keen to enjoy the enhanced economic and social benefits of
e-commerce also appreciate, although they do not always openly express it
as such, that there is a need to clarify the issue of establishment in order
that they may reap the consequential tax revenues brought by e-commerce.
It must also be noted that the determination of establishment may also
assist in the enforcement of other matters receiving regulatory attention; as
it will permit greater ease to exert jurisdictional control over those areas
subject to such regulation.
In relation to determining establishment, much may be drawn from
10
The Safe Harbor principles agreed between the United States and the EU seek to provide a solution to
these issues by permitting transborder data transfers between the EU and US. However, their effectiveness
is tempered following statements by the EU stating that they primarily address large multinational
companies transborder data transfers and their wider application to the Internet is, as yet, unresolved. See:
International Safe Harbor Privacy Principles, U.S. Department of Commerce, 14 March 2000; and comments of
the ECs First Secretary in Washington, Gerard de Graf, reported in, US and Europe Reach Tentative Pact on
Personal Data, New York Times, 23 February 2000.

JAMES CATCHPOLE

those heavily regulated areas of activities involving financial services and

income tax regulation. However, this is another area in which e-commerce
and the Internet again challenge the application of traditional jurisdictional concepts and rules.11 An essential element of any tax system is the
ability of taxpayers to discern their potential tax liabilities. Accordingly, an
inability to distinguish boundaries in e-commerce has produced difficulties in identifying the location of the services or products being used, or to
know with any degree of certainty where they might be subject to taxation.
Hence, establishment and the surrounding issues are receiving increasing
attention.
The question is thus, in which jurisdiction does a permanent establishment exist for e-commerce businesses? Whilst there is no doubt that
e-commerce is challenging traditional jurisdictional concepts, the Organisation for Economic Cooperation and Developments (OECD) Committee
on Fiscal Affairs has suggested that the principles underlying international
norms in tax treaties are capable of being applied to e-commerce, and so
may provide a solution for determining establishment.12

3.1

The application of Comity

To start, whilst national governments may possibly be able to claim the

application of their laws and regulations to e-commerce activities originating in different jurisdictions, the principle of comity is applied to limit the
extra-territorial effect of such laws i.e. the requirement that states should
not apply their laws to persons in other states unless it is reasonable to do
so. The United States Supreme Court, in Hilton v. Guyot, defined comity as
the recognition which one nation allows within its territory to the legislative . . . Acts
of another nations, having due regard both to international duty and convenience
. . . .13 However, as Reed notes, the legislators ability to maintain comity to
activities within a jurisdiction is challenged by the Internet, particularly in
association with establishment, which, Reed further notes, is an elastic
concept.14

3.2

The European Courts approach to Establishment

To assist in the clarification of the issue of establishment, the European

Court of Justice (ECJ), in the Somafer15 case, provided a definition of
establishment as being:
11
See: EC Commission, supra; United States Department of the Treasury, Discussion paper entitled
Selected Tax Policy Implication of Global Electronic Commerce, November 1996, and The White House, A
Framework for Global Electronic Commerce, July 1, 1997.
12
OECD, The Application of the Permanent Establishment Definition in the Context of Electronic Commerce:
Proposed Clarification of the Commentary on Article 5 of the OECD Model Tax Convention, 3 March 2000 at 3.
13
115 U.S. 113, 163164, [1995].
14
C Reed, Internet Law in Context, Butterworths 2000, Chapter 7.
15
Case 33/78 [1978] ECR 2183.

THE REGULATION OF ELECTRONIC COMMERCE

The concept of branch, agency or other establishment implies a place of business

which has the appearance of permanency, such as the extension of a parent body,
has a management and is materially equipped to negotiate business with third
parties, so that the latter, although knowing that there will if necessary be a legal
link with the parent body, the head office of which is abroad, do not have to deal
directly with such parent body but may transact business at the place of business
constituting the extension.
The ECJ reaffirmed the application of establishment as a right for
corporations under Article 52 of the EEC Treaty, as was, in the Daily Mail
case.16 It is also worth noting that the Daily Mail case found that it does not
follow that corporations have the right to transfer its place of central
management to another state, particularly if the aim is to move the fiscal
residence of a head office an important clarification should e-commerce
businesses be seeking to take advantage of the difficulties in determining
establishment and implement tax avoidance schemes. It must also be noted
that determining the existence of a permanent establishment is a separate
inquiry from revenue characterisation or source of income, a matter this
paper does not intend to investigate.
Following the ECJ decisions, three components are generally required
for the determination of establishment, namely, the:
use of fixed premises or equipment in a jurisdiction;
presence of staff (including possibly intermediaries); and,
ability of those staff to undertake business transactions with
customers within that jurisdiction.
Whilst such criteria may be suitable for the physical world, invariably
requiring an establishment plus component i.e. in the sense that a
business will not only be required to have a presence within a jurisdiction
(whether that be premises, equipment or staff), but will also need to be
undertaking some form of activity within that jurisdiction17 it is becoming
apparent that such criteria are not necessarily suitable for e-commerce and
the internet. For instance, the ECJs decision in relation to gaming
machines in Berkholz v. Finanzamt Hamburg-Mitte-Altstadt,18 that an installation can only constitute a fixed establishment where there are also staff
permanently present in the jurisdiction to operate the installation, has
been interpreted to mean that this would apply equally to other forms of

16

Case 81/87 [187] ECR 5483.

For example, in the United Kingdom, the Income and Corporation Taxes Act 1988 relies on the ability
to establish where a corporation is resident and what (and where) is the source of specific income or
profits which are potentially within the scope of taxation. This latter being the plus element.
18
[1985] ECR 2251.
17

JAMES CATCHPOLE

machines.19 E-commerce immediately raises new and difficult questions in

the context of the application of the concept of permanent establishment.
Whilst it may be possible in the case of equipment that may be easily
determined as fixed, it will not always be possible, or appropriate, to
determine establishment on such basis for e-commerce operators.
To determine the application of establishment to e-commerce operators
it will be necessary to decide whether: a website on a server owned or used
by a [foreign] enterprise, accounting for the fact that there may not
necessarily be employees present in the source country (i.e. where the
revenue is acquired), amount to establishment? will such websites constitute a place of business? can a server then be said to be fixed and will the
undertaking of periodical automated business functions (i.e. advertising,
ordering, or payment) constitute the carrying on of a business through
such a fixed place of business?

3.3

Has legislation assisted in determining establishment?

Legislation, rather than assisting, has already raised a number of queries in

the interpretation of the principles of establishment. For instance, the
EUs Data Protection Directive (Article 4(1)(c))20 requires that data
controllers when established on the territory of several Member States or, if
not established in the EU, but processing personal data in a Member State,
comply with the appropriate national legislation. The application of the
term establishment is unclear in the context of e-commerce, although
Recital 19 to the Directive does provide that establishment . . . implies the
effective and real exercise of activity through stable arrangements.
Whilst both the Recital and Article 4(1)(c) appear to assist in clarifying
some difficulties, bringing foreign data processors into the ambit of the
Data Protection Directives provisions, as they will be using equipment
situated in the EU, it fails to address some of the potential issues that
e-commerce poses. For example, it has been argued that the placing
of cookies may even constitute establishment.21 Clarification is obviously
required in the context of e-commerce in this particular example as it is
difficult to fully understand the application of this proposition. E-commerce websites viewed on a users computer are not sufficient to create a
virtual branch, such as for banks since the e-commerce operator may have
neither premises nor staff within the jurisdiction and the users computer
is only used temporarily22 is, therefore, the placing of cookies any different?
Arguably not, since cookies are text file mechanisms by which server
side connections may store and retrieve user-related and preference
19
Eden, The Taxation of Electronic Commerce, Law & the Internet Regulating Cyberspace, Ed. by Edwards
& Waelde, Hart Publishing, at 157.
20
EU, supra.
21
Schwartz & Reidenberg, Data Privacy Law: A Study of United States Data Protection (1996).
22
C Reed, supra.

THE REGULATION OF ELECTRONIC COMMERCE

information, such as passwords or users preferred destination pages in

websites, on the client side of a web-based connection. However, should
their function exceed the mere recognition of users, and be used to
collect/ process additional user information. It would be questionable
whether they would be afforded the exemption under the OECD Model
Income Tax Convention on Income and on Capital 199823 (Article
5(4)(d)), discussed below. Whilst this argument may be supported by the
proposition that a cookies life-span, normally set for 12 months, permits
cookies to be re-activated upon the users return to a website, they are,
however, neither fixed, as a user may decline their placement or delete
them, nor do they perform any discernible activity in the execution of a
business transaction.

4.

The OECDs Reconciliation of

Establishment with Electronic Commerce

Turning again to the issue of taxation, it has already been suggested that
supranational and double taxation treaties may provide a solution by which
establishment may be determined.24 However, the application of tax
concepts of residence and permanent establishment to cross-border
business, designed upon principles dating back to the international tax
treaties following the League of Nations draft conventions (19271933),
and more recently the OECD, have been placed under considerable
pressure by the emergence of e-commerce.
The ECJs interpretation of establishment is consistent with definitions
contained in most double taxation treaties, which require that a business
must have a permanent establishment in a jurisdiction before that
jurisdiction is able to tax the business profits of the enterprise. When
determined to be so established, a business will be subject to the corporate
income tax of that jurisdiction, but the existence of permanent establishments in multiple countries may create cash flow disadvantages for
e-commerce businesses. Thus the issue is, to what extent business
operations utilising the Internet creates a permanent establishment for the
participants?

4.1

The OECDs Model Income Tax Convention on Income and

on Capital

Of the treaties in place, the OECDs Model Income Tax Convention on

23
24

OECD, Draft Model Tax Convention on Income and on Capital, 30 June 1998.
OECD, supra.

JAMES CATCHPOLE

Income and on Capital 1998, is one of the most highly regarded and, has
influenced many of the double taxation treaties currently in existence. It is,
therefore, an appropriate focus for the determination of establishment. In
assigning taxing rights over business operations, the OECD Conventions
concept of permanent establishment is used to determine whether the
enterprise has brought itself within any particular taxing jurisdiction.
Under Article 7 a jurisdiction may tax an enterprises business profits
attributable to a permanent establishment located in that country,
regardless of the enterprises country of residence for tax purposes.
Permanent establishment is defined under Article 5 as a fixed place of
business through which the business of an enterprise is wholly or partly carried on,
including specifically an office, branch or place of management. The
Convention additionally provides guidance for excluding from permanent
establishment status the use of facilities solely for the purpose of storage, display or
delivery of goods or merchandise belonging to the enterprise; the maintenance of a
stock of goods or merchandise belonging to the enterprise solely for the purpose of
storage, display, delivery, processing by another enterprise; maintaining a fixed place
of business solely for the purpose of purchasing goods or merchandise or of collecting
information, for the enterprise, to carry on any other activity of a preparatory or
auxiliary character.25 Whether the application of these exemptions to
e-commerce activities is possible, is open to question, thus rendering many
of them inappropriate. In addition, the Convention and its exemptions is
further undermined by the fact that they are and are dependent upon a
jurisdictions own view and interpretation.
The Convention also provides that an enterprise will not be deemed to
have a permanent establishment as a result of carrying on a business
through brokers, general commission agents, or other independent agents
acting in the ordinary course of their business.26 On the other hand, a
dependent agent who has, and who habitually exercises, the authority to
conclude contracts in the name of an enterprise will create a permanent
establishment for the enterprise on whose behalf the agent is acting.27
The Commentary to Article 5 of the earlier 1992 Model Income Tax
Treaty appeared to provide additional guidance that may have been
applicable to the emerging e-commerce industry. It stated that a permanent establishment might exist if the business of the enterprise is carried
on mainly through automatic equipment , with the activities of personnel
restricted to setting up, operating, controlling, and maintaining such
equipment. However, this early Commentary is illustrative of the challenges that e-commerce has posed the Commentary was initially
developed in response to gaming and vending machines, where the users
entire transaction is conducted by interaction with the machine, but has
25
26
27

OECD, supra, Article 5(4).

Ibid., Article 5(5).
Ibid., Article 5(6).

THE REGULATION OF ELECTRONIC COMMERCE

proved of limited application to e-commerce, and is currently being

amended.28

4.2

The Determination of fixed places of business

Thus, the determination of whether an e-commerce operator will be

deemed to have a particular fixed place of business, as a result of Internet
generated sales, and thereby establishment, will need to be considered in
the light of:

4.2.1 whether the location of computer files constituting a website on

a server located in a jurisdiction is a particular site and thus
a place of business with sufficient permanence to be a fixed
place of business.
It is important to distinguish between the server and the website. The latter
does not, in itself, involve any tangible property and may not therefore
constitute a place of business, as there is no facility such as premises or, in certain
circumstances, machinery or equipment in accordance with Article 5. In
addition, being visible in a jurisdiction is not synonymous with, nor does it
entail, a physical presence in a jurisdiction. A websites server, on the other
hand, is equipment having a physical location and, combined with the
websites software contributing to the function performed in relation to
the business, may, in theory, constitute a place of business.29
In order that servers may constitute a permanent establishment, it will be
necessary that they meet the requirement of being fixed under Article 5(1)
i.e. that a server is located at a certain place for a sufficient period of time.
However, the manner in which servers are used will not necessarily make
the application of the test or the Article 5 straightforward. For instance,
servers may be located in buildings situated in countries in which
enterprises have no other presence; or, on a portable computer used in
different places within a building or moved from city to city.30 Further, the
use of linked servers in different jurisdictions switching signals from one to
another during the performance of a service, thus avoiding being fixed,
makes it harder to determine which server in which jurisdiction is used for
which portion of the activity for the purposes of determining establishment. Should an e-commerce operator wish to implement a scheme by
28
Bloom & Giusti, International Tax Implications of Electronic Commerce on Outbound Transactions, The
International Tax Journal, Vol. 23, No. 4, 1997.
29
OECD, supra. Although it has been argued that a server should not be considered a permanent
establishment, since they are not automated without software or in effect anything more that telephone
lines or information recording or disseminating mechanical machines.
30
See: Bloom & Giusti, supra, at 54, in which it is noted that there have been exception to the concept of a
fixed location, citing German cases that held that moveable places of business with temporary fixed
locations (such as market stands) can meet the location test in the permanent establishment definition.

10

JAMES CATCHPOLE

which to ensure that its enterprise does not fulfill the requirement of being
fixed, it would only have to have one website which is electronically
transferred in total, every so often, to new servers in different buildings,
cities or countries. In addition, it is not uncommon for a number of mirror
websites to exist on different servers located in different countries
directing customers to any of them for any function in order not to be
subjected to congestion arising in Internet traffic. The UKs Inland
Revenue has already stated that servers used solely for advertising would
not likely be a permanent establishment, further noting the practical
realities in that websites held on servers may be switched to alternative
servers.31
Consequently, it may be necessary to apply a contrasting view to that
which believes servers may constitute establishment, as noted by the
OECD.32 In relation to the core functions of an enterprise, it is stated that
the communication tools used in the selling process should be of no
consequence, whether the transaction is concluded by mail order, by
telephone or through a server based website, the form in which a product is
delivered (physically or electronically) should make no difference for the
way in which it is taxed. Thus, only in exceptional cases would a permanent
establishment exist, for example where the relevant transaction (the
conclusion of a contract, the payment and the delivery of the goods) is
handled fully (automatically) by the server, itself. However, commentary
on this view,33 which also expresses the opinion that the presence of a server
(including one that hosts a website) in a jurisdiction could not give rise to a
permanent establishment, must to some extent be flawed. The argument
that a server is not typically the type of equipment through which business is
carried on cannot be sustained, since it is obviously not the case as far as
e-commerce is now concerned. Consequently, whilst this view may be
appropriate in some circumstances, as technologies develop permitting a
greater proportion of a business to operate via a server, it must be a view
that should not, necessarily, prevail, rather it is one that will become
out-dated.

4.2.2 who owns the website contents and/or the server.

The enterprise that operates the server may be different from the
enterprise that carries on business through the website, for example, it may
be possible that an e-commerce operator may own the website but lease the
server from a service provider, lease both the website and server from the
service provider or lease the website and server and share various functions
with the service provider.

31
32
33

See: C Fairpo, Taxation of Electronic Commerce: Residence, The Tax Journal, 18 January 1999, at 8.
OECD, supra, para. 14 to draft Article 5 Commentary.
See: Sprague & Hersey, Letter to OECD re Electronic Commerce, Intertax, Volume 27 Issue 2, 1999.

11

THE REGULATION OF ELECTRONIC COMMERCE

Where a website is hosted on an Internet Service Providers (ISP) server,

although the fees paid may be based on the amount of disk space used to
store the websites software and data, such arrangements do not typically
give the website operator any right to particular space or control over the
operation of the server. Consequently, the server and its location are not at
the website operators disposal, even if agreement has been reached that
the website should be hosted on a particular server at a particular location.
Since the website operator will not have a physical presence at that location
and, because a website should not be viewed as tangible assets, the website
operator cannot be considered to have acquired a place of business by
virtue of that hosting arrangement. The OECD has suggested that where
the e-commerce operator owns, or leases, and operates the websites server,
then, provided the other requirements of Article 5 are satisfied, the
operator could constitute a permanent establishment.34
In addition, it must also be considered whether an ISP may be deemed to
constitute permanent establishments for e-commerce operators by virtue
of the websites operated through the servers owned and operated by ISPs.
The only application under which this may be possible is under Article 5(5)
of the OECD Convention, which states that where a person is acting on behalf
of an enterprise and has, . . . an authority to conclude contracts in the name of the
enterprise, [it] shall be deemed to have a permanent establishment in that State in
respect of any activities which that person undertakes for the enterprise . . . In
practice, ISPs will not constitute an agent as they will invariably have
neither authority to conclude contracts on behalf of e-commerce operators, nor will they constitute independent agents acting in the ordinary
course of their business, as they will most likely host websites for many
e-commerce operators. Additionally, since a website is obviously not in
itself a person as defined by Article 3 to the Convention, Article 5(5)
cannot therefore deem a permanent establishment to exist by virtue of the
website being an agent of the enterprise.

34

OECD, supra, para. 3 to draft Article 5 Commentary.

12

JAMES CATCHPOLE

4.2.3 whether a website may be considered solely an exempt display

of goods35 and so seek exemption in accordance with the
OECDs Article 5 exemptions or, may it be considered as the
tax equivalent of a mail-order catalogue or, is regarded as an
entire sales outlet located in a jurisdiction i.e. does a website
go beyond the types of preparatory and auxiliary activities
which, under Article 5(4), would not result in a permanent
establishment?
In assisting in this analysis, New York case law draws the analogy between
conventional media and Internet advertising in which it is suggested that a
website containing information that simply advertises (solicits) business in
New York does not amount to transaction of business and would not
subject a host to personal jurisdiction under the New York Civil Practice
Laws and Rules.36 It is also worth considering the application of Atkin LJs
test, in FL Smidth & Co. v. Greenwood,37 for determining where a trade is
being carried on. Although the test may have a limited application to the
activities of e-commerce, it states: where do the operations take place from which
the profits in substance arise? In that the substance of the operation is
invariably the conclusion of a contract, it may be appropriate to look for
the end result of the on-line commercial activity. The OECDs own guidance
on this matter lists a number of activities which, by themselves, would
generally be regarded as preparatory or auxiliary; namely, the provision of
communications link between suppliers and customers; and/or advertising of goods or services; relaying information through a mirror server for
security and efficiency purposes.38
In addition, the language used by the OECD Convention, suggests that
the mere solicitation of orders (in essence, the purpose for which a
mail-order catalogue is used) via the Internet is unlikely give rise to a
permanent establishment, and would arguably fall under the auxiliary or
preparatory activity exemption of Article 5. Should service companies be
employed to process orders and clear payments, it may be concluded that
such service providers have sufficient authority to bind a foreign enterprise
in the activity and, if exercised habitually, give rise to permanent
establishment. Although, it must be noted, that the exemption under
Article 5(6) may apply to such activities as it [is] [carrying] on business . . .
35

AS Bloom & RS Giusti, supra at 54.

Under the New York Civil Practice Laws and Rules, a person is deemed to have transacted business in
New York by reference to the totality of its contacts with New York, if it [has] purposely availed itself of the
privilege of conducting activities. See: Greenberg v. R.S.P. Realty Corporation 253 NYS 2d 344 (App. Div. 1964);
and Simplicity Mach & Mfg. Co. v. Stevens Co. 292 NYS 2d 259 (App. Div. 1968).
37
(1922) 8 TC 193.
38
OECD, supra, para. 12 to draft Article 5 Commentary.
36

13

THE REGULATION OF ELECTRONIC COMMERCE

through a broker, general commission agent or any other agent of an independent

status, . . . acting in the ordinary course of their business.
However, this issue has to consider the various functions (or combination of functions) that can be automated, such as advertising, ordering,
payment, storage and digital delivery, and the extent to which a database of
digital contents may constitute a stock of goods and, if that is the case,
whether the database may be said to be maintained solely for the purposes of
storage, display or delivery if it also has a search and reporting facility (e.g., if
a customer can select the contents of the database merely for viewing).
Should jurisdictions determine that any such functions form an essential
and significant part of the commercial activity of e-commerce operators, or
where other core functions of the enterprise are carried on through the
computer equipment, such functions must be deemed to go beyond the
auxiliary or preparatory activities (and, if the equipment constituted a fixed
place of business), then e-commerce could find that some of its activities
may be determined sufficient for establishment in those jurisdiction. This
may also be applicable in relation to what may be considered as the core
function of the e-commerce operator and the equipment itself if, for
example, the sales functions is performed through the computer equipment (whether the product is delivered on-line or otherwise), the
equipment would constitute a place of business and thereby be a permanent
establishment. But, again, this would need the certainty that the equipment is fixed.
In addition, in respect of the exception included under Article 5(4)(d),
concerning the collection of information, it is unclear the point at which
mere collection of information substantially becomes processing of raw
information that is collected. For example, should the EUs Data Protection Directive be applicable, its broad definition of processing39 (that
includes any operation performed upon personal data, including collection, storage, adaptation or alteration, disclosure by transmission and
dissemination) will, most likely, encompass anything that is done with
personal data as processing, and will probably exceed the threshold for the
mere collection of information permitted under the exemption, thus
rendering it inapplicable to e-commerce operators.

4.2.4 the extent to which human intervention is required to

determine a permanent establishment.
As the OECD notes, there appears to be two schools of thought in relation
to whether some form of human intervention is required.40 Where it is
stated that some human intervention is necessary, the interpretation of the
39
40

EU, supra, Article 2 and 9.

OECD, supra, paras 611 to draft Article 5 Commentary.

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JAMES CATCHPOLE

exact parameters of that requirement differs. The OECD list three

differences, namely:
whether the intervention must necessarily take place in the country or
can be done from abroad;
whether the intervention needs to be that of employees of the enterprise
or of any person, whether or not employed by the enterprise;
what level of human intervention is required.41
In relation to the first, the view put forward is that only when intervention
by persons present in the country where the equipment is located takes
place, may the e-commerce operator be regarded as participating in the
economic life of that jurisdiction. Obviously, when it is not possible to
maintain or operate equipment remotely, there will be a greater assumption of establishment in the location of the personnel. The second issue is
stated as one that an operator may only be said to be carrying on business
activities in a jurisdiction through equipment located in that country if the
equipment is operated by persons, whether or not employed by the
enterprise. The third raises the question of how to distinguish between the
operation of equipment from its maintenance, especially when databases
or software are upgraded, and the level of human intervention for each for
a permanent establishment to exist.
An approach that appears to be both more logical and appropriate to
e-commerce is that automated equipment, that does not require human
intervention for its operation, may constitute a permanent establishment.
The question thus becomes the nature of the business and whether the
activities performed through the equipment are the core income-generating activities of that business. In this respect, e-commerce activities can be
analogous to other activities in which equipment operates automatically, as
applied by the German Supreme Tax Court. The German Courts pipeline
decision,42 found permanent establishment when a Dutch company owned
and used German underground pipelines and provided, through computers, pressure to transport the oil by remote control from the Netherlands to the German oil companies. By analogy, it would appear that a sale
or service provided to customers over the Internet through the use of a
server in the customers jurisdiction by a foreign supplier is generated by a
permanent establishment in the customers jurisdiction. Although commentary upon this analogy has limited its application to the provision of
Internet services, rather than to the sale of, say, jeans etc.,43 it would appear
41

Ibid.
30 October 1996, II R 12/92, Betriebs-Berater 1997, p. 128 (cited in 97 TNI 3621 at 12). See Professor
L Hinnenkens, The Challenges of Applying VAT & Income Tax Territorially Concepts & Rules to International
Electronic Commerce, Intertax, Volume 26, Issue 2 at 63; and Sprague & Hersey, supra, for contrasting
interpretations of this case, the latter argues that the case is distinguishable.
43
Ibid., at 64.
42

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THE REGULATION OF ELECTRONIC COMMERCE

that it is a logical conclusion that personnel are not necessary for a

permanent establishment when no personnel are in fact necessary to
generate income. Further, support for this conclusion may be drawn from
the fact that no explicit reference for a requirement for human intervention is included the OECD Conventions definition of fixed place of
business, and paragraph 10 of the existing Commentary to Article 5 already
recognises that automatic equipment may constitute a permanent
establishment.

4.3

Has the OECD kept apace?

As demonstrated above, the OECDs Convention, and, by default, it may be

assumed many traditional tax laws and treaties by which establishment is
determined, envisage a single website or server being responsible for the
entire contracting purpose and is in fact struggling to keep apace with the
actual operation of e-commerce. The OECD, in issuing its latest revisions,44
anticipates to clarify the application of permanent establishment and
address the difficulties that e-commerce has created in the interpretation
of previous double taxation treaties, and to some extent, case law. Of
importance is the OECDs recognition that a distinction must be made
between computer equipment, such as servers (which may constitute
permanent establishment under certain circumstances), and data and
software which is used by, or stored on, that equipment, particularly as the
entity operating a server may be different from that carrying on business
through a website. However, it must, therefore, be questioned whether the
traditional approaches for determining establishment under long-standing principles, such as the OECDs, which are invariably based on a
requirement for activity [in order that tax may be collect], need overhauling and replaced with a concept that is more applicable to e-commerce.

5.

The European Unions Approach

5.1

The EUs Electronic Commerce Directive

The EU, in specifically targeting its legislation at the Internet and

e-commerce, has been the latest legislative body to address the issue of
establishment and has attempted to produce a coherent approach. The
EUs Electronic Commerce Directive,45 approved by the European Parlia-

44

OECD, supra, due to be finalised in September 2000.

See: Common Position adopted by the Council with a view to the adoption of a Directive of the
European Parliament and of the Council on Certain Legal Aspects of Information Society Services, in Particular
Electronic Commerce, in the Internal Market; Council of the European Union, Brussels, 28 February 2000,
98/0325 (COD)14263/1/99 REV 1.
45

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JAMES CATCHPOLE

ment on 4 May 2000,46 is regarded as preparatory for Europes transition to

a knowledge-based economy, by ensuring that Information Society services
benefit from EU Internal Market principles of free movement of services
and freedom of establishment. The Directives primary aim is the
harmonisation of areas such as where operators are established, transparency obligations for operators and commercial communications,
conclusion and validity of electronic contracts, Internet intermediaries
liabilities, on-line dispute settlement and the role of national authorities.
Whilst it is not the specific aim of the Directive, the EUs approach to
establishment is both interesting and new. Further, the Directive also
makes an important step in the actual regulation of the Internet and
e-commerce activities. By virtue of Article 4 and Recital 22, the Directive
provides that Information Society services should be supervised at the source of the
activity, in order to ensure an effective protection of public interest objectives,47 thus,
the Directive has taken steps to ensure regulatory certainty by providing
that once an e-commerce operator is established within a jurisdiction, it is
that jurisdiction that regulates its activities. This will, in theory, eliminate a
number of difficulties that have been experienced in everyday activities,
such as commercial promotions and offers (such as 2-for-1 promotions)
that contravene German competition laws.
Defined under the Directives definition of established service provider, it is
stated that establishment is where a service provider:
. . . effectively pursues an economic activity using a fixed establishment for an
indefinite period. The presence and use of the technical means and technologies
required to provide the service do not, in themselves, constitute an establishment of
the provider; 48
It is intended that this definition, stated as being in line with ECJ case
law, will remove legal uncertainty and ensure that operators cannot evade
supervision, as they will be subject to supervision in the Member State
where they are established (the Directive will not apply to service providers
established outside the EU49). However, the definition cannot be read
alone. As is becoming a common requirement in the interpretation of EU
legislation, it is necessary to turn to the Recitals for additional guidance.
Recital 19 states:
The place at which a service provider is established should be determined in
conformity with the case-law . . . according to which . . . establishment involves the
actual pursuit of an economic activity through a fixed establishment for an
46
EC Press Release, Electronic Commerce: Commission Welcomes Final Adoptions of Legal Framework
Directive, 4 May 2000. The Directive is due be implemented within 18 months of its publication in the
Official Journal.
47
EU, supra, Recital 22.
48
EU, supra, Article 1(2)(c).
49
EC, supra.

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THE REGULATION OF ELECTRONIC COMMERCE

indefinite period; . . . also fulfilled where a company is constituted for a given

period; the place of establishment of a company providing services via an Internet
website is not the place at which the technology supporting its website is located or
the place at which its website is accessible but the place where it pursues its
economic activity; in cases where a provider has several places of establishment it is
important to determine from which place of establishment the service concerned is
provided; in cases where it is difficult to determine from which of several places of
establishment a given service is provided, this is the place where the provider has
the centre of his activities relating to this particular service;
Thus, the EU has sought to rely upon established EC Treaty principles and
ECJ case law and defined the place of establishment as the place where an
operator actually pursues an economic activity through a fixed establishment, irrespective of where websites or servers are situated or where the
operator may have a mailbox. It has sought to remove some of the
difficulties currently experienced in the adaptation of the physical worlds
legislation for the determination of establishment to the on-line world.
Further assistance in determining establishment is the obligation upon
service providers to make available basic information concerning their
activities, of which, the most significant is the provision of the geographic
address at which the service provider is established.50
By clearly stating its parameters, and requiring service provider to state
where they are establishment, thereby removing some of the requirements
for various authorities to undertake the exercise of that determination, the
Directive has moved away from previous models of establishment that
encompass a establishment plus element. It will no longer be necessary, as is
required under various national legislation, such as the United Kingdoms
Income and Corporations Taxes Act, 1998, to show additional requirements of activity within a jurisdiction. However, whilst the scope of the
Directive is not intended to apply to the field of tax,51 the application of rules
established in existing double taxation treaties will no doubt assist in
resolving some issues for some e-commerce operators.

5.2

The Emergence of a new Concept of Establishment?

The important result of the Directive is that it is promulgating a new

concept for the application of regulation of commercial activities within a
region. Thus, once determined as established within a Member State of the
EU, e-commerce operators will, without question, be subjected to regulatory control within those Member States. The possible underlining tone of
the Directive is the emergence of a principle by which a commercial
50
51

EU, supra, Article 5(1)(b).

Ibid., Article 1(5)(b).

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JAMES CATCHPOLE

activity, for which it may not necessarily be possible to determine that their
activities etc. are confined to one geographic jurisdiction, will become,
ultimately, determined upon a regional basis.

6.

Conclusion

Whilst there can be no doubt that e-commerce has and will continue to
challenge, many of pre-existing rules and regulations that are common
place within geographic areas and jurisdiction, the ability to embrace and
control the Internet and e-commerce will depend upon authorities and
legislative bodies to determine where such activities take place. Obviously,
establishment is one such area of concern, but one of significant
importance for ensuring that both regulatory controls are applicable to
and, that the consequential social and economic benefits (of which, the
collection of tax revenues is one factor) are derived from the Internet and
e-commerce are obtained.
However, e-commerce has proved itself apt at not following the expected
norms and capable of being able to circumnavigate pre-internet models of
establishment. In the physical world, vendors who change locations
regularly would undoubtedly lose its customers, in contrast, the location of
a server is irrelevant to e-commerce customers as they will have access to the
business goods or services wherever they have Internet access. A further
complication, given the expected progress of cable and satellite technology, is anticipated once bandwidth limitations are overcome, making it
possible to locate most, if not all, of the functions of an Internet business in
any country. In fact, the consequences are so profound that the OECD has
acknowledged that concept of permanent establishment may be ill-adapted
to e-commerce and that many bilateral and multilateral tax treaties may
have to be amended or scrapped in order to accommodate international
e-commerce taxation regimes.52 Obviously a coherent approach is
required to ensure that establishment may be determined.
The EUs Electronic Commerce Directive appear to be implementing a
new approach that would determine establishment upon a regional basis,
thus overcoming many of the geographical constraints experienced by
national legislation, and double taxation treaties.53 In fact, this notion of
approaching such an issue on a regional basis is one that has already
52
Chan, Taxation of Global E-Commerce on the Internet: The Underlying Issues & Proposed Plans, 9 Minn. J.
Global Trade 233, at 268.
53
Further, with emergence of proposals for new regulations amending Regulation (EEC) No 218/92 on
administrative co-operation in the field of indirect taxation (VAT) and Directives amending Directive
77/388/EEC as regards the value added tax arrangements applicable to certain services supplied by
electronic means, intended to create a level playing field for digital e-commerce taxation in accordance with
the principles agreed at the 1998 OECD Ministerial Conference, these will no doubt be further adoption of
similar principles. See EC Press Release, IP/00/583, Taxation: Commission proposes amendments to the
VAT treatment of electronically delivered services.

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THE REGULATION OF ELECTRONIC COMMERCE

received (although muted) consideration. In relation to taxation at source,

discussions have raised the issue that it could be expanded and liberalised
to insure that all countries receive a fair share of electronic commerce tax
revenue. This is illustrated by the tension between two OECD broad, but
potentially incompatible, policy goals. In October 1998 the OECDs
Committee on Fiscal Affairs policies stated that existing tax principles
should apply to the taxation of electronic commerce but, another policy
goal, the maintenance of sovereignty and fairness, could conflict with the
goal of preserving existing principles.54
The consequence is that the OECD appears to be stating that the fiscal
sovereignty of countries and a fair sharing of the tax base generated by
e-commerce are more important than a strict (or possibly even loose)
adherence to existing technical tax principles. In addition, e-commerces
removal of the middleman from business transactions resulting in lost tax
revenue is receiving increasing concern.55 Whether these concerns will
result in far-reaching changes to the international tax regime or a material
reallocation of the worlds tax revenue remains to be seen. The risk that
such changes will have to address will be to prevent businesses without a
permanent establishment (as that term is currently understood) in a
particular country being subjected to taxation in that country. However,
what is clear is that the governance of e-commerce will have to be
consistently applied, of which establishment is only one issue. The EUs
approach may appear to be the start of a process whereby, at least for
e-commerce, establishment is determined on a regional basis with the
consequential tax revenue and legislative responsibility being shared
proportionately between regional members.

54
OECD, OECD Ministerial Report, Electronic Commerce: Taxation Framework Conditions, October
1998, at 4. In relation to the former goal, the OECD commenced the revision of the Commentary to the
Model Tax Convention.
55
Forst, Old & New Issues in the Taxation of E-Commerce, Berkely Tech Law Journal, Issue 14:2, 1999.
The example given is the loss of tax revenue by the UK as customers purchase, say books from Amazon.com
rather than from a local bookseller, cutting out the UK middleman and losing the UK tax revenue.

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