What to consider when structuring an E-commerce Business
E-Tail, E-commerce, or online sales businesses are a common business activity we deal with when consulting for a new corporate structure at Flag Theory.
There is a myriad of factors to look at when structuring an e-commerce company such as the place where the goods are manufactured, bought and processed, the location of the operations, the distribution infrastructure, the location of the servers and the customers, the payment services required, among many others.
Ecommerce companies tend to be global businesses with interests in different jurisdictions. This global approach may provide for a number of operational and commercial benefits, but may also affect your tax obligations and provide for greater and more complex structuring needs.
These structuring needs can, and must, be also used for obtaining commercial and operational advantages, and a positive impact to the bottom line.
In this article, we have highlighted some considerations to take into account when considering a new or expansion or overhaul of a corporate structure. This article mainly deals with retail e-commerce, however, many of the observations made can perfectly apply to B2B scenarios.
Note that the following is a comprehensive review of the topics discussed, and it is not and should not be construed as legal advice or tax advice of any kind.
Generally, the location of a customer may not be the most relevant factor in determining the source of income and income tax liability of a given e-commerce business.
Although this may change in the future with the introduction of ‘digital tax’ schemes, right now, from a structuring and tax perspective, it’s important to look at the place where the business activities that generate income are carried out.
The distribution infrastructure and fulfillment model may be one such activity, and it may have significant importance from a structuring standpoint, and might also carry tax implications. Note that this section references to income tax, and not VAT, GST or other forms of sales taxes.
A foreign company with a fixed place of business in a third country will generally need to pay taxes in this third country on the profits attributed to the place of business. That’s known as a Permanent Establishment (PE).
If there is a double-taxation agreement (DTA) between the two relevant jurisdictions, one should look carefully at the specific definition of a permanent establishment, and whether the specific activities of this place of business will be considered a PE.
Generally, DTAs follow the OECD’s Model Income Tax Treaty, whereby a facility used solely for the purpose of the purchase, process, storage, display, or delivery of goods or merchandise, would not be considered a PE. Using facilities for quality inspections, packing and labeling wouldn’t trigger PE provisions. However, there are nuances in each tax treaty that must be carefully evaluated.
The general approach is that a foreign company may have an in-house fulfillment order facility in a third country without triggering permanent establishment provisions and without being subject to taxes in this third country.
One should consider aspects such as whether this facility runs as an independent business, how it is managed, the origin of the goods, whether sales activities are carried out within the country, among others. If the ‘fulfillment’ country deems that the foreign company has a permanent establishment, profits would usually be attributed to the PE as if the ‘head office’ was conducting transactions at arm’s-length with such PE.
For instance, if the company is obtaining additional sources of income from a warehouse by renting out storage space or other facilities, this would be considered a permanent establishment.
If there is no tax treaty in place, it’s important to consider the domestic tax law. If under domestic tax law, the foreign company is deemed to have a PE, the company could be taxed twice on the same income, if no tax credits are granted in the country of tax residency for foreign tax paid.
In such cases, one might consider setting up a foreign subsidiary in the customers’ country which will import, purchase the goods from the parent company on an arm’s-length basis, and carry out sales activities within the country. That could also provide certain other commercial benefits, such as access to local financial services like payment processors, country domains, among others.
Note that even while having a warehouse space or equipment may not trigger PE provisions for the foreign company, one should take into account that hiring local staff and possessing local management may be required. In a number of countries, that alone could mean that the company must register a subsidiary or branch office, which would be taxed locally.
However, the subsidiary will need to act totally independently in order to not be considered a PE of the foreign parent company. This means, for instance, that the subsidiary should have its own board, should not conclude contracts on behalf of the parent company, and will exclude the parent company’s employees, among others.
Using a third-party logistics provider (3PL) would generally not trigger a PE. However, there are certain caveats.
For instance, if the foreign company personnel have access to a 3PL’s warehouse for inspection or other purposes, that alone might lead to it constituting a PE of the foreign company. Again, this would largely depend on the tax treaty and specific case-law. Other aspects, such as whether the goods stored already belong to a customer, or if they are inventory, might also need to be evaluated.
Other factors to consider include the source of income, and the place where the goods are manufactured.
A foreign company that purchases goods manufactured in a country, which is then exported and sold to third countries, would generally not constitute a PE in the country of purchase. The mere purchase of goods may not lead to a company constituting a PE, even if there is a physical place for storing such goods. In the customers’ country, as long as an independent importer and distribution agent is used, PE provisions would not apply.
However, if the foreign company purchases goods manufactured in a country, which is stored, processed and sold to customers within the same country, that would generally be deemed a local source of income and thus taxable locally in that country.
For instance, a foreign company that purchases goods in the US and distributes such goods in the US may be deemed to engage in a US Trade or Business (USTB) and may have US effectively connected income (ECI), even if the company does not have any physical presence or is not deemed to have a PE in the US.
If the goods are manufactured by a third-party overseas but are purchased in the US, i.e. the legal title of the goods passes within the US, and are distributed to US customers, that might constitute ECI and be taxed in the US as well.
However, if the goods manufactured overseas’ legal title changes outside the US, the so-called “title passenger rules” apply, and no US federal income tax may be applicable, even if they are stored, sold and distributed to US customers.
Generally, if the goods are manufactured by the seller overseas, income arising from such goods would be deemed as foreign-source and thus not taxable.
Note that treaty provisions may mitigate tax liability in a foreign country. For instance, a foreign merchant accruing local-source income in a treaty country might not be taxed in that country, provided that it does not have a permanent establishment, subject to treaty provisions.
Note that there are a number of exceptions and each case should be evaluated separately by a professional tax attorney.
The above details regarding distribution are of significant importance for foreign merchants using online marketplaces with fulfillment services such as Amazon FBA, one of the most popular forms of e-commerce. The place where the goods are manufactured or purchased, and whether the country of tax residence of the foreign company has a tax treaty with the country in which the goods are fulfilled, may have enormous tax implications for the foreign merchant.
Generally, for cross-border drop shipping-type of distribution models, whereby the foreign merchant’s wholesaler ships the goods directly to the customer – generally, the merchant might not be construed as having a PE in the customers’ country as long as the wholesaler is located and goods are shipped from overseas and are directly imported by the customer or by an independent shipping company.
In that scenario, whether such income will be deemed local-source income in the customer’s country will largely depend on the specific provisions of the domestic tax law, or the specific tax treaty provisions (if any).
It must also be noted that merchants seeking to do business through online marketplaces should consider their onboarding policies. Online marketplaces may not support companies incorporated from a number of jurisdictions, or may not support settlements to bank accounts domiciled in certain countries.
This section applies to companies that sell their own created products directly to consumers via their e-commerce facilities.
If the company handles the full manufacturing process within its manufacturing facilities in a foreign country, that would constitute a place of business, and therefore, a PEt.
The company will likely need to be registered as a foreign company and it may be taxed locally for the income-generating activities carried out through the PE.
The merchant company may also consider setting up an affiliated entity in this foreign jurisdiction, which will be in charge of manufacturing the goods. This affiliate company will own and/or have the necessary tools to conduct its business such as premises, manufacturing equipment, and labor, and will be administered and managed separately from the main merchant company.
The manufacturing company will not be authorized, or will not enter into contracts on behalf of the merchant company. Furthermore, employees of the merchant company won’t have access to the facilities and would be excluded from the activities of the manufacturing company, among other considerations.
If both companies are acting totally independently according to the considerations explained above, and transactions between the merchant company and the manufacturing company are conducted on an arm’s-length basis, in certain instances, the merchant company might not be deemed to have a PE in the manufacturing jurisdiction.
Alternatively, companies could outsource their production processes to overseas manufacturers via toll manufacturing or contract manufacturing arrangements.
Generally speaking, the main difference between toll and contract manufacturing is that in contract manufacturing, the third-party company sources all raw materials and produces the product, whereas, in toll manufacturing, the third-party company provides manufacturing processes using raw materials or semi-finished goods provided by the principal company.
Usually, in a contract-manufacturing arrangement, no PE of the principal company may be constituted. The contract manufacturer is a vendor in the supply chain, and the principal company purchases certain goods from the said vendor.
In a tolling-arrangement, the manufacturing company is usually independent of the principal company, i.e. it is not exclusively providing services to the principal company, and is responsible for the product quality and product defect risk. Therefore, it does not usually trigger PE provisions for the principal company.
Note that if the goods produced/processed by the contract manufacturer/toll manufacturer are sold within the same country, this could trigger PE provisions. In certain cases, an independent marketing and sales agent on a non-exclusive basis may be used to avoid such scenarios.
Many e-commerce companies operate online with their own websites. These websites are used for marketing and sales purposes and are hosted on servers.
These servers may be owned by the company or leased from a Cloud service provider via a website hosting agreement. Generally, if the website hosting is leased from a Cloud service provider, it would be deemed as an independent agent for PE purposes, and the merchant would not be considered to have a PE in the country where the servers are located.
However, certain countries, especially those that host a significant number of websites, may consider that just a mere web hosting agreement may constitute a PE in the country, and that profits that arise from the websites should be attributed to this PE.
Imports and Markets
International online retailers may be able to choose between several models when it comes to importing goods in their customers’ countries, and these models may have structuring and tax implications. Importing certain types of goods may be prohibited or subject to a special license. Usually, those products are related to tobacco, alcohol, pharmaceuticals, dairy products, copyrighted products, etc.
Importing goods in a given country usually carries import duties The import duty tariffs may also depend on the good’s Harmonised System Code (HS Code) and country of origin.
Import tariffs may vary depending on the goods’ origin. Most favored nations, i.e. countries with which the importing country has a trade deal, may enjoy lower or zero rates on certain goods imported.
Import tariffs may also vary depending on whether the goods are imported for commercialization or directly to consumers. Furthermore, VAT must be paid when importing goods.
In addition, each country has its own customary practices and regulations when it comes to returning and replacement of products under warranty, and whether these may be subject to or exempt from customs duties.
Importers may also need to obtain an import license and be registered with the relevant customs and tax authorities.
Online retailers may use a broker or a shipping agent that is the importer of record, and ships the product to the customer.
A foreign online retailer may also use a fulfillment agent which serves as importer and 3PL.
Alternatively, the merchant may register the foreign company with the destination country’s Tax & Customs, and establish its own local distribution infrastructure. The foreign company may also use a local subsidiary for that purpose, as explained in the previous section.
Imports may be under the freight Incoterm DDP (delivery duty paid), whereby the seller bears transportation, customs clearance, and import duties expenses, or DDU (delivery duty unpaid), whereby the buyer bears the cost of import customs clearance, and import duties and taxes. Certain countries do now allow imports under DDP, while others do not.
Merchants may also require processing and/or inspecting the goods using a freight-forwarder, or be the middleman themselves between the manufacturer and their own fulfillment facility or fulfillment agency. In the latter case, the merchant could register in a free economic zone / free-port and re-route the goods from origin to destination.
As we’ve seen, an international online retailer may use different models for importing goods, depending on their specific needs, the specific jurisdictions in which they operate and have clients, and the import volumes in such jurisdictions. Each model may have different structuring needs and tax implications.
For instance, if the goods shipped are subject to high tariffs, and DDP is not permitted, shipping directly to consumers via a shipping company may have negative commercial and customer experience consequences. In that case, the merchant may choose to set up its own local import and distribution infrastructure or engage with a 3PL in that jurisdiction to avoid dealing with the regulatory and paperwork burden.
In addition, certain jurisdictions also impose certain licensing requirements for selling goods to their residents. For instance, if a foreign company wishes to market their products via the large Chinese online marketplaces, it will need to set up a Chinese subsidiary in the form of Wholly Foreign-Owned Enterprise (WFOE) and obtain a Business license.
From a legal and tax perspective, indirect taxes on the supply of goods are, perhaps, some of the most complex areas that a given global e-commerce company will handle. In this section, we provide a short review of two of the most complex cases: the US and the EU, whose territories have different VAT / Sales Tax Rates.
For jurisdictions with uniform taxation, the process is usually simpler – the importer of record is in charge of paying VAT when importing goods, who in turns charges VAT to the customer, and cancels input and output VAT in their periodical returns.
In a previous article, we discussed some of the key VAT aspects to take into account, for international companies selling their goods across the European Union.
For EU B2C e-commerce companies, they will generally pay VAT at the rate of the country of their goods’ port of entry (and any applicable customs duties).
Then, VAT would generally be charged at the rate of the Member State in which the consumer is located. The EU merchant would need to register for VAT and file VAT returns in each of the countries where they are selling. The registration procedure will be relatively eased by 2021 with the One-Stop-Shop (OSS) scheme, whereby multiple VAT identification numbers in different countries will not be required.
There is an exception to the above: the so-called distance sales thresholds. If the distance sales threshold in a specific country is not surpassed, the merchant can charge its local VAT rate, and report VAT in its own country.
The distance sales thresholds vary depending on the country: Germany, Luxembourg, the Netherlands, and the UK have a EUR 100,000 threshold, whereas Spain, Italy, France, Belgium, Finland, and Austria have a EUR 35,000 limit.
Non-EU companies without a European PE importing and/or selling in the EU will need to appoint a VAT fiscal representative in each of the countries they are trading with (if they surpass distance sales thresholds), who will deal with filing obligations and may be jointly liable for VAT payments of the company.
Appointing a fiscal representative is not mandatory in all countries – the Netherlands, Germany, UK and Czech Republic, among others, have waived this requirement.
The distribution model also matters – if the end-consumer is the importer of record, he or she will incur VAT and customs duties, if applicable.
If the company is the importer of record, it will need to register for VAT and EORI in a given port of entry, and charge VAT to the customer, as previously explained. If the company is using a 3PL, registering for VAT is also mandatory.
However, if the merchant is using marketplaces and electronic interfaces such as Amazon or eBay, these online platforms will be liable for collecting VAT on behalf of non-EU suppliers.
Two supplies will have been deemed to have taken place – a B2B supply between the merchant and the Marketplace, and a B2C supply between the marketplace and the end-consumer.
This may allow for eliminating the burden for non-EU e-commerce companies using online platforms having to register for VAT in each of the countries where their customers are located.
In addition, as of 1 January 2021, companies selling goods to end-consumers across different Member States will be able to use the OSS scheme and will no longer be required to have multiple VAT ID numbers and report VAT in the various EU Member States. Under the OSS scheme, the supplier will charge local VAT in the Member State where the customer is located, but VAT registration and reporting will be done in a single Member State.
With regard to the US, most States levy Sales taxes on the sale or lease of goods and services. Rates vary between 2.9% and 7.5%. A few states do not levy sales taxes, namely Delaware, Montana, Oregon, and New Hampshire.
Unlike EU VAT, Sales taxes in the US are not generally levied on imports of goods that are going to be resold, or in raw materials. However, each State has different regulations on that matter.
Sales taxes are applied to goods sold to consumers. Whether a merchant needs to collect, report and remit Sales Taxes will largely depend on the products sold, their sales volume, and its ‘nexus’ with the State where the consumer is located.
The Sales Tax Nexus is usually evaluated considering a number of variables, which vary depending on the State. These generally include whether the business has a physical presence in the State (such as an office or warehouse or personnel), has inventory stored within the State (regardless of whether a 3PL is used) or drop shipping relationships within the State, among others.
Most States have a Tax registration threshold, whereby merchants that have sales volumes and/or a number of transactions below certain thresholds are exempt from registration. Sales volumes usually vary between USD 100,000.00 and USD 200,000.00, and transaction thresholds between 100 and 200.
If the merchant is considered to have a nexus with the State and exceeds the registration thresholds, it must register for a Sales Tax Permit and will be assigned a due date for sales tax and filing frequency schedule, which may vary depending on the sales volume. This also applies to foreign companies, which will also need to obtain a US Employer Identification Number (EIN) to apply for a sales tax permit. A foreign company may face higher challenges to obtain a Permit and collect Sales Taxes and may consider using a US subsidiary for its US business.
Both US and foreign merchants using fulfillment agencies, or popular marketplaces with fulfillment service such as Amazon FBA may have a Sales Tax Nexus with different US States. Amazon uses fulfillment centers across different states to store inventory. A given Amazon Seller may have a Sales Tax Nexus in each of the States where their goods are stored. There are two exceptions to this: New York and Virginia, where the mere fact of using a third-party for logistics does not create a Sales Tax Nexus.
Note that Sales Taxes are taxes levied by the State and not taxes levied by the Federal Government, meaning that a given foreign company could be exempt from Federal Income Tax on their US trade or business income due to a tax treaty, yet still have a Sales Tax Nexus in the State where their customers are located.
Larger e-commerce businesses with a global presence may use different companies formed and operating within different regions to address their various business and market needs.
These affiliated local operating companies may source the goods from an affiliate supplier, or provide certain services to their head offices, such as management, marketing or distribution services, among others. Companies within the same group structure, under the same beneficial ownership or within a management-dependent relationship may enter into transactions with one another regularly in their normal course of business.
These intra-group transactions would be subject to transfer pricing regulations and must be conducted at arm’s-length, meaning that the amount charged by one related party to another for a given product or service must be the same as if the parties were not related. Transfer prices must be in line with market prices.
As intra-group transactions can dramatically impact the tax base of the involved entities, these have traditionally been used in different structuring and tax planning strategies involving ‘onshore’ and ‘offshore structures’, especially for transactions involving non-physical and/or mobile businesses such as financing, leasing, shipping, intellectual property or services.
This has led to the creation of specific legislation to mitigate artificial transactions between related entities. There needs to be a real business and commercial substance backing these transactions.
Most jurisdictions have transfer pricing rules in place modeled after OECD guidelines, with the exception of low-tax or no-tax jurisdictions. However, offshore jurisdictions are implementing economic substance requirements for companies conducting certain mobile activities and/or intra-group business. Economic substance is also increasingly required in a number of double-tax agreements, in order to access treaty benefits.
Firms must also produce transfer pricing documentation related to their intra-group transactions, which must generally be submitted to their relevant tax office. Furthermore, in most jurisdictions, a given Tax Office may have the right to adjust profits or losses of a company – and consequently a given company tax base, if compensations arising from intra-group transactions differ from compensations which would have been made between independent actors.
Certain jurisdictions exempt SMEs transacting with affiliates from transfer pricing rules and/or being obligated to produce transfer pricing documentation, up to a certain turnover amount. These exemptions may only apply to treaty countries or only to transactions made to jurisdictions with certain levels of taxation. Some jurisdictions have established a transaction threshold below which a given company may be exempted from complying with transfer pricing rules and/or transfer pricing documentation. A properly structured multinational e-commerce SME may rely on these exceptions to soften its compliance burden.
For multinational e-commerce groups with presence in various jurisdictions, and which are subject to the transfer pricing at arm’s-length principle compliance, they may opt for various other methods for calculating a transfer price.
Companies carrying out transactions with goods or services that can be easily valued in the market can use the comparable uncontrolled price method, which sets a transfer price that is the same as the current market price for those goods or services – the fair market price. In certain instances, an adjusted market rate price can be used, which incorporates certain adjustments to the comparable uncontrolled price.
Manufacturers tend to use the cost-plus-percent method, which consists of adding a margin onto the cost. This margin should be reasonable in considering an unrelated party’s transaction in a comparable situation, including similar risks and market conditions. When no margin is added, the transfer price is deemed to be calculated on a cost basis.
Distributors and resellers might calculate the transfer price using the re-sale price method, which uses the margin as a transfer price based on a given product’s sale price, minus the price of acquisition and all related costs for the transaction.
Another increasingly common way to calculate the transfer price is using the transaction net margin method, which uses the net profit margin earned by a similar uncontrolled transaction conducted between unrelated parties to calculate the transfer price.
The transfer price can also be calculated using the profit-split method – which is based on how unrelated parties would have divided profits on a given transaction – and determines the contribution of each related entity to a given good or service according to available market data.
Each transfer pricing methodology fits different business activities and specific circumstances and products. Multinational companies should seek help from experienced accountants and business consultants to properly implement transfer pricing policies and process management systems across their organizations.
Proper structuring and transfer pricing strategy may not only provide tax benefits; transfer pricing may also be used for optimizing exchange profit remittances, foreign currency fluctuations, and exchange controls, as well as the optimal allocation of resources across different business units and departments.
The ability to accept credit/debit card payments is critical for e-commerce businesses.
Merchants require a number of services for accepting credit card payments, such as a payment gateway, payment processor and merchant acquirer, all of which can be provided by the same financial institution, or various different services providers.
Generally speaking, the payment gateway collects the payment information and forwards it to the payment processor, which in turn forwards it to the card association (e.g. Visa) which routes the transaction and the payment authorization request to the card-issuing bank. The card issuing bank authorizes the request and the payment processor forwards the authorization response to the payment gateway. This process usually takes seconds.
At that point, the whole process is repeated again to clear the authentication with the card-issuing bank, which in turn settles the transaction with the merchant acquiring bank, which then deposits the fund with the settlement account of the client. This process can take a few days.
Therefore, in addition to its own settlement account, a merchant will need to contract the services of a payment gateway and processor and open a merchant account.
The use of merchant aggregators is also common, especially for small businesses. Merchant aggregators use their own single master merchant account to process the payments of hundreds of businesses. The aggregator then settles the credit card payments in each individual merchant’s current account. Although sometimes slightly costlier than having an individual merchant account, payment aggregators are popular due to the ease of opening accounts and integrating with the merchant’s website, among other reasons. Some of the most popular payment aggregators are PayPal and Stripe.
The availability to access to these payment solutions may vary dramatically depending on a range of factors, including but not limited to the merchant’s business activity, and its place of incorporation and tax residency. Therefore, when structuring your e-commerce business, payment processing should be one of the top aspects to take into account.
Furthermore, transaction fees can also vary dramatically depending on the business activity, location, volume, chargebacks and refund rates, etc., and can range from 0.5% to 10%, which may have a tremendous impact on your business’ bottom line. Generally, a low-risk business formed in a low-risk / financially developed jurisdiction will pay around 2-4% on transaction fees.
Due to compliance and fraud-avoidance reasons, Card Associations apply certain rules on financial institutions providing acquiring services, and other services providers. Similarly, the same financial institutions may also have certain onboarding policies and restrictions.
Some of these rules and policies might include the stipulation that merchant acquirers can only onboard local clients and settle payments to local bank accounts and in local currency. Furthermore, payment aggregator solutions may also have limited supported countries.
Certain jurisdictions, such as the US and the EU, may have a highly-competitive landscape with multiple options available, whereas other jurisdictions may be more limited in that regard.
Therefore, your place of incorporation and banking will affect your merchant processing options.
For instance, an offshore company may have limited options to choose from. Offshore companies are usually considered non-resident companies for tax purposes in the jurisdiction in which they are incorporated. They may be de-facto or de-jure restricted to deal in the local currency, and offshore banks have seen their ability to provide merchant solutions diminished in recent years.
This means that an offshore company may be unable to secure a merchant account, and would, therefore, need to rely on payment aggregators. Most payment aggregators do not onboard offshore companies or have very strict onboarding policies, and some of them charge large transaction fees and rolling reserves.
A common solution to this issue has been to either form an ‘agency’ in an onshore jurisdiction, or to contract the services of a third-party agent. The agent company would then receive the payments on behalf of the principal (operating company) and remit them. The agent company would then charge some fees for providing this service.
There are certain caveats to be considered when using these structures, such as whether the arrangement would be considered a regulated activity, as well as other tax and transfer pricing considerations. Furthermore, some merchant processing providers explicitly prohibit such activities in their terms and conditions / customer agreements.
It is also a common practice to set up related entities in local markets for accessing local payment solutions. The ability to accept local digital payment solutions such as wallets in a given market may significantly affect customer conversion rates.
In previous articles, we commented on the importance of properly protecting and structuring the intellectual property assets of a given business.
Companies building a global e-commerce brand with business operations in a number of countries should also consider putting in place an IP structuring strategy. Taking this step can bring the benefits of optimized tax planning, asset protection, and financing strategies, which is explained further in “how to protect and structure an IP holding company”. Having intellectual property assets properly organized also allows a company to leverage additional business models for entering new markets, such as franchising.
Trademarks are, perhaps, the most sensitive IP asset for international e-commerce companies that sell their own brands’ products directly to consumers. This is especially the case if they are trading in global markets, which puts them at risk of counterfeiting or opportunists looking at making a quick buck.
Trademarks should be registered in each jurisdiction where a company wishes to seek protection. Although there are certain supranational options such as the EU Trade Mark or the Madrid System and Protocol, certain countries have a track record of not enforcing or ignoring International Agreements.
For instance, if you wish to enter the Chinese market, you should register your brand’s Chinese name with the Chinese Trademark Office (CTMO) in advance, to avoid potential issues related to counterfeiters and the use of your brand’s name by third parties.
Furthermore, e-commerce companies entering certain markets may want to obtain a Country Code Top-Level Domain (ccTLD). Certain jurisdictions only allow their country’s’ specific domains to be registered by residents (whether individual or juristic persons). In such cases, it will be necessary to establish a local entity for that purpose.
Consumer Protection and Confidence
In international online transactions, generally, an online merchant’s country consumer protection and contract laws apply, unless the merchant has agreed to apply the consumer’s country laws via the terms and conditions that govern the sale – which rarely happens.
Contract law regulates contracts, enforcing them and applying a fair remedy when there’s a breach. Consumer Protection law is developed to address consumer rights in unbalanced agreements such as adhesion contracts (e.g. Terms and Conditions of an online sale), where the consumer cannot negotiate such contracts.
Consumer Protection laws generally regulate consumer rights during the pre-purchase and post-purchase phases.
Consumer Protection in a pre-purchase scenario might protect consumers from unclear and non-transparent information, deceptive pricing schemes, other unfair commercial practices in general, or spam.
Consumer Protection laws, and also Contract laws, may also regulate and control terms and conditions and other electronic contracts imposed on consumers, pricing disclosures, and online payment security, among others, in a purchase scenario.
In a post-purchase scenario, Consumer Protection and Contract laws may also regulate consumer rights such as the right to a cooling-off period or a refund, timeframe for delivery, liability for damaged goods, or dispute resolutions.
However, Consumer Protection laws greatly differ between jurisdictions, and a given merchant should be aware of the legal and regulatory requirements in the jurisdiction(s) where it is doing business.
Furthermore, it is considerably challenging for a given customer to file claims and seek enforcement consumer protection laws when dealing with a foreign merchant. This could considerably affect a merchant’s customer confidence and, therefore, conversion rate when entering into certain markets.
Given the non-physical nature of consumer-merchant relationships, it seems logical that a given consumer would prefer dealing with a merchant located in the same jurisdiction and/or region. Therefore, the merchant’s structuring strategy should be aligned with its commercial and business plan.
Merchants and consumers should also consider privacy laws; for instance, the EU’s General Data Protection Regulation (GDPR). The GDPR is perhaps the strictest data protection law worldwide and regulates how businesses collect, use and store customers’ personal information, e.g. name, address, date of birth and/or credit card number. GDPR has extraterritorial reach – any business that has EU customers should be compliant with GDPR.
The Bottom Line
There are a variety of factors to take into account when structuring a retail e-commerce business.
Your distribution infrastructure and the operations carried out in different jurisdictions may have a significant impact on your tax liability and reporting requirements. Whether you use 3PL, have your own local infrastructure to market and distribute your products, or use a dropshipping business model, may also determine whether your company is considered as having a permanent establishment and should be taxed locally. The jurisdiction in which web servers are located may also need to be evaluated for permanent establishment purposes.
Furthermore, the place where the goods sold are manufactured, whether a merchant is manufacturing its own goods or the type of business relationship it holds with third-party manufacturers should also be considered when structuring a given firm.
One should also take into account where customers are located, which will determine the obligation of collecting consumption taxes and the requirement to register with and report to local tax authorities.
Medium and large e-commerce businesses should properly structure intra-group transactions when multiple entities are in place, in order to serve different markets, and/or carry on different operating or holding activities – in order to comply with transfer pricing regulations and leverage the multiple tax, operational and capital efficiency benefits that international structuring can provide.
Another key aspect to consider when setting up an e-commerce company is accepting payments. Not having a reliable payment processing provider can significantly affect your conversion rates, or even put you out of business
Card Associations, Merchant processing providers and other Financial Institutions have different onboarding policies and fee structures. The place where your company is formed, operated and banked may have an impact on your available options and transaction costs.
Protecting and structuring intellectual property in the countries where a firm does business or plans to do business will also be important. This is especially the case for merchants selling their own products and/or companies building a global marketplace brand, or companies entering into certain markets where counterfeiting is common.
Last but not least, merchants should also take into account and comply with applicable consumer protection and privacy laws. Privacy laws of certain jurisdictions may have extra-territoriality. Furthermore, merchants expanding into new markets may consider establishing local operations to boost customer confidence as a result of being subject to local consumer protection laws.
All in all, your structuring and tax strategy should be properly aligned with your commercial and operational activities; they must go hand-in-hand. You need to consider the whole supply-chain when structuring your company.
Today, we’ve reviewed some critical aspects you should take into account when setting up your company for your e-commerce business, but there are many more.
Flag Theory can help you design and implement the proper structure with jurisdictional comparison intelligence customized to your specific business, your specific personal circumstances, and your goals. We make sure that our solutions are aligned with your business plan and your personal objectives.
We are experienced in working with businesses in a variety of industries and we take into account not only all the legal, regulatory, and tax elements, but also the commercial needs, priorities, and goals of your business.
Our goal is to empower you to legally benefit from the highest asset protection, risk management, fully legal tax minimization, and smooth finance and commercial operations. Contact us today, it will be a pleasure to assist you.