Tax

Is time running out for unregulated international software sales?

Tanva Mahitivanichcha Tanva Mahitivanichcha

The growth of the digital economy and trade in intangible digital products has seen governments wrestle between the desire to embrace and promote the new economic landscape and the need to regulate it. Thailand is no exception. The government’s recent high-profile solicitation of China’s leading e-commerce operator, Alibaba, to collaborate in developing the nation’s digital economy made front page news. Equally newsworthy were the government’s current attempts to revise existing tax laws to ensure that digital transactions are subject to VAT, and that capital gains from disposal of digital assets are subject to withholding tax.

There are rich and complex issues related to the issue of taxing transactions in the digital realm, but these will be discussed at a later time. In this article, we will focus on the digital economy from a customs control perspective. Principally, we will explore whether intangible digital products – such as downloadable computer software, mobile phone applications, music, movies, and news publications – transmitted across national borders should be subjected to customs control, and thus dutiable.

These questions are not new, and considerations surrounding the main issues remain as complicated as when they were first posed.

For instance, the World Customs Organization (WCO) made an effort to tackle the issue of intangible digital products as far back as 1984. At that time, the WCO technical committee on customs valuation issued guidelines on how computer software should be valued for customs duty assessment purposes. Known amongst the practitioners of customs and trade law as “Decision 4.1”, the WCO adopted the position that the value of software that is embedded in a carrier media should not be subject to customs duty assessment.

In other words, if an importer brings in a 1-dollar compact disc that has 100 dollars’ worth of software programs embedded on it, the importer should only pay import duties based on the tariff rate applicable to the compact disc itself at the value of 1 dollar. Naturally, this position seems to favour countries that are net exporters of software, whereas developing countries including Thailand have refused to apply Decision 4.1.

For countries like Thailand that declined to adopt Decision 4.1, the customs authorities would include the entire value of the embedded software for customs duty assessment purposes. In other words, using our prior example, Thai customs would value the compact disc at 1,001 dollars for duty assessment based on the tariff rate applicable to compact discs.

Our example presupposes that there is a sale of the digital product (compact disc plus embedded software). Generally, owners of intangible digital products don’t “sell” their software to users. Rather, these transactions are coached in the form of licenses, whereby the user is actually granted a right to use the products. This is an important legal distinction as a sale implies a conveyance of not only the object of the sale but also ownership title. The buyer could thus be entitled to resell or duplicate the product.

Thus, there is a question of whether right-to-use transactions are “sales” as determined by the World Trade Organization’s (WTO) customs valuation principles. The WTO customs valuation principles, which are adopted by all WTO members including Thailand, stipulate that the value of goods for customs purposes is the transaction value of the goods, which is the price paid or payable for the imported goods when sold for exports to the country of importation. Where there is no sale, such as in the instance of rented items, the customs authorities may attempt to value the item based on the

rental value or the useful life of the item. This framing raises the problem of how we should value a digital product license that may be paid on a per-use basis or on a renewable periodic basis. There is no concrete answer.

Thirty years later, in 2014, several WCO members proposed revising obsolete elements of Decision 4.1. The term “carrier media”, as originally defined to include magnetic tapes, was too narrow and does not seem to apply to newer storage devices such as USB flash drives. Unfortunately, in this author’s opinion, an attempt to redefine carrier media is probably impractical given that intangible digital products are now primarily transmitted electronically.

The complexity does not end here. There is a further issue of whether intangible digital products are deemed to be “goods” for the purpose of customs controls and duty assessment. Are intangible goods to be treated in the same matter as physical goods? Or is it actually form of service? Or is it neither – something distinctive in and of itself?

The legal community has struggled with this issue. Commenting on the problems of how to treat intangible goods, the late US law professor Raymond T. Nimmer observed that aspects of the traditional contract laws are relics of a disappearing industrial economy and are ill suited to handle the complexity of a modern economy that is driven by exchange of services, information and technology.1 Legal scholar Veronika Vilímková observed that the European Court of Justice at one time ruled the transmission of television signals to be a provision of services and not a movement of goods, but later went on to confound the legal community when it deemed transmitted electricity to be categorised as goods.2

In 1998, the WTO issued a moratorium on taxing global electronic commerce, to allow for the development of a comprehensive framework that would tackle trade-related issues. Under the moratorium, member countries agreed to refrain from imposing customs duties on electronic transmissions. This moratorium is not permanent and was a temporary measure pending members reaching a consensus on a comprehensive framework for e-commerce. To date, however, there is still no updated framework and the moratorium continues to be renewed every two years.

In 2000, the WCO Secretariat issued classification advice to its members to the effect that the harmonised commodity description and coding system (also referred to as the harmonised system) applies only to the media (i.e., the way the information or data is presented) and not software. As such, software which is not presented in the form of a carrier media (i.e., embedded in physical objects such as compact discs, USB flash drives, or hard drives, etc.) are implicitly not goods for customs purposes. This in turn means that software transmitted over the internet is not subject to customs control. While this classification advice is not binding for members, countries such as Thailand have, to date, adhered to this principle.

Problem solved? Not quite.

The world appears to be heading towards an era of digital protectionism, with countries expressing desires go their “own way” in regulating their digital economy as a challenge to the WTO and WCO’s liberal trade order. According to a report by the Financial Times in 2017, 70 out of the WTO’s 164 members declared their intention to sidestep the WTO and conclude their own negotiations in

bilateral or plurilateral deals on electronic commerce.3 India, in an exercise of negotiating brinksmanship, blocked the 1998 moratorium’s renewal when it was about to expire at the end of 2017. While the moratorium was renewed at the eleventh hour – much to the relief of global tech companies – the cracks in liberal digital economy regime are apparent.

2018 has already seen a direct challenge to the existing free flow of digital commerce, with Indonesia issuing a new regulation that paved the way for customs duties to be assessed on electronically transmitted intangible goods such as software and digital products. Indonesia created new classification codes to treat intangible digital software as goods for customs control purposes. Nonetheless, in a spirit of restraint and adherence to the 1998 moratorium, Indonesia ultimately applied a 0% tariff rate on the new software classifications. However, the country’s message is clear and unequivocal: should it want to, Indonesia has a right regulate and impose customs duties on digital products.

While the Thai government has yet to state a clear desire to impose customs control over intangible digital products, the issue of controlling the flow of intangible digital products into Thailand is not far from the government’s mind. As mentioned at the top of this article, the Thai government is seeking to impose VAT on foreign electronic commerce transactions with Thailand. The government has also signaled that, if such new laws are implemented, it would block the websites of foreign electronic commerce operators that do not comply and pay the proposed VAT.4 It may only be a matter of time before Thailand follows Indonesia’s lead, and begins taking steps to impose customs controls over intangible digital products.

References

1 See Raymond T. Nimmer, Intangibles Contracts: Thoughts of Hubs, Spokes and Reinvigorating Article 2, Williams & Mary Law Review, Vol. 35, Issue 4, 1994.

2 See Veronika Vilímková, The Concept of Goods in The Case Law of the Court of Justice, International Journal for Legal Research, Vol. 6, No. 1, 2016.

3 Financial Times, WTO Wrestles with relevance in age of ecommerce, 14 Dec. 2017.

4 The Nation, Foreign Websites to Come under VAT Net, 7 March 2018.