21 November 1997

 15 November 1997, Network Computing:

 Welcome To Cyberspace. Your Papers Please? 

 About a year ago, the Treasury Department issued a little-noticed discussion 
 document entitled "Selected Tax Policy Implications of Global Electronic 
 Commerce" (www.ustreas.gov). Beavering away in obscurity, these unelected 
 technocrats have almost finished turning the broad "implications" into detailed 
 regulations. Like most tax rulings, these regulations require no further 
 congressional action to have the force of law. So, while rehabilitated Clinton 
 apparatchik Ira Magaziner was out mesmerizing the digerati with his 
 "Framework for Global Electronic Commerce," promising free markets and no new 
 taxes, the green-eyeshade boys were quietly laying the groundwork to launch the 
 IRS into cyberspace. 

 The new regulations are being promoted as a means to develop uniform rules by
 which software distributed over the Internet is to be taxed, particularly when
 distribution occurs across national borders. This has been a nagging issue for
 software publishers worldwide who, when they aren't busy fighting pirates, must
 worry about the threat of double taxation for electronically distributed
 material-paying income taxes in the country of origin as well as royalty taxes in the
 country of sale. 

 Resolution of this issue would no doubt be welcomed by the industry. The solution
 that will be proposed by Treasury before the end of the year comes down on the
 side of subjecting software publishers only to income tax, exempting them from
 foreign royalty taxes. This works to the advantage of governments from countries
 that export more software than they import, a fact that will not go unnoticed by
 our trading partners. 

 So how will foreign governments be brought into line with this policy? A Treasury
 attorney with whom I spoke indicated that the United States is prepared to lead an
 effort to achieve "global consensus." What goodies will we offer to coax foreign
 taxing authorities into going along? And how will the problem of Internet tax
 havens be dealt with-a looming issue in digital commerce-as it becomes ever easier
 to set up remote servers that can distribute content from almost anywhere? 

 Speak Software and Carry a Big Stick One answer being considered will bring a
 chill to privacy advocates, especially because Treasury has announced intentions
 to expand the initial regulations covering software distribution to cover all forms of
 digital content: text, music, video, photos-you name it. 

 The fundamental problem with collecting taxes in cyberspace is that bits are bits.
 Who knows what is really flowing over those T3 lines? Customs or postal
 inspectors can easily pry open a package to see whether the contents include a
 CD, a T-shirt or a bundle of greenbacks. But how is this job to be accomplished
 on the Internet, especially since, as the Treasury Department so quaintly observes,
 "the use of encryption could preclude comprehension." 

 The classic strategy of forcing reporting requirements on key "taxing points," such
 as banks, clearinghouses and other financial institutions, is not likely to work as
 the need for intermediation on the Internet will be vastly reduced. In many ways,
 that's the whole point of electronic commerce. Any reporting burdens must be
 pushed out to the end points of each transaction. How will this be done? This is
 where Big Brother may arrive big time. 

 Under active consideration is a plan to require taxpayers to obtain digital IDs for all
 electronic transactions, keeping records that could be examined on audit. The IDs
 would be issued by IRS certified agencies, subject to government developed
 standards to ensure that proper identity checks are performed before anyone is
 allowed to shop online. The IRS would enforce this by issuing its own digital
 certificates to issuers of digital IDs so that they can electronically prove that they
 have received IRS certification. The technology they need to make this happen is
 available. All that's missing are the regulations forcing compliance. So, stay tuned.
 If you enjoyed the encryption key escrow debate, you'll love this one. 

 Bill Frezza is a general partner at Adams Capital Management. The opinions
 expressed here are his own. He can be reached at frezza@alum.MIT.EDU or