E-Commerce and Intellectual Property Essay
E-Commerce and Intellectual Property
E-commerce is defined by the UNCITRAL as “Transactions in international trade are carried out by means of electronic data interchange and other means of communication commonly referred to as ‘electronic commerce’, which involve the use of alternatives to paper-based forms of communication and storage of information”. The rapid expansion of e-commerce is forcing countries to look again at how to regulate trade and intellectual property.
The amazing development of telecommunication devices and means, and of computers and related services, has made all these services and products available to a very large number of people in the world. In highly-developed countries, the use of computers has been highly promoted, and it is normal to find people who are fully familiarized with computers and who are used to dealing with computer technologies such as the Internet.
Relying On Private Agreements
At the present time, the development of e-commerce has several barriers, such as the lack of security for electronic transactions, and the low purchasing power of a large part of the population, most of whom do not have credit cards. Also, people prefer to buy goods from real shops rather than from virtual shops due to the lack of security in electronic transactions and the increased problems relating to the falsification of credit cards, signatures and mail theft among others.
First of all, to login to an information network, people use several programs and devices to retrieve information. People use computers, modems, switchboards, communication devices, routers, hubs, etc, and each one of these products may be the subject of a patent or a copyright, and whenever there is an intellectual property right involved, there is the possibility of an infringement.
Secondly, a great deal of information is published in the Internet, and all this information is exposed to misuse. Probably, one of the most frequent practices on the Internet is that users take parts of web pages and copy them onto their computers; from then on, they are able to use, reproduce and modify the retrieved information to the extent they wish. This may infringe intellectual property rights such as trade marks, trade names, slogans or copyrights.
Protection under the IP law
Legislation modifications should be focused on trade laws and even more on international trade laws. The intellectual property laws are reasonably prepared to handle the boom of e-commerce activities in the forthcoming years, with provisions that offer the means to protect all intellectual property rights. Probably, the recent creation of the so-called “domain name” is the reason why it has not been included yet in most intellectual property laws. But, even in some countries, policies have been created for the registration of domain names and if necessary, procedures for cancellation of registration in cases of infringement of intellectual property rights.
More often than not, one of the most valuable assets in e-commerce and the largest potential source of future income is the information database created across time in the joint venture. Unfortunately, some e-commerce proposals do not even mention this. But if the information-gathering activity is not mentioned, the possibility of failure persists, to negotiate the legal rights to that information and the income it generates.
Enhancing the upside of e-commerce takes careful contract analysis and planning. E-commerce, in general, and strategic online partnerships in particular, are continuing to emerge and evolve in ways that are increasingly attractive to associations and their members. But at the same time that associations are realizing the benefits of such relationships, certain new legal developments require careful analysis to ensure that the association avoids potential legal and financial risk associated with its online activity.
Unfortunately, the legal environment does not yet have much legal precedent on which lawyers and their clients may rely. At the same time, new legal developments are emerging. These realities pose tough challenges with regard to minimizing the association’s legal risks while maximizing its economic rewards. Consequently, forging the effective low-risk partnerships desired will be nearly impossible to do solely. Rather, the association’s legal counsel will need to pay particular attention to the details of the online partnerships the organization may consider–as well as the contracts that define them.
New Legal Developments
Three of many developments complicating e-commerce legal analysis are the case of United Cancer Council; the Intermediate Sanctions portion of the Internal Revenue Code; and the Uniform Computer Information Transactions Act, which is currently being introduced in all state legislatures for enactment.
United Cancer Council
UCC is a spin-off of the American Cancer Society. The IRS retroactively revoked UCC’s federal income tax exemption for its long-term contract in a joint venture with a for-profit company. In short, UCC lost in the U.S. Tax Court, won a reversal and new trial on appeal, and recently settled with the IRS before the second tax court trial. Based on my experience as one of the UCC lawyers at the tax court trial and on my observations of the interactions of IRS lawyers at that time, it is firmly believed the IRS will now apply its UCC positions to e-commerce ventures of nonprofit organizations.
The IRS positions that emerged from this case should raise a red flag for associations when it comes to the planning and development of their own online joint ventures. In essence, associations must scrutinize arrangements in which
• There is too much contractual control of the venture by the for-profit;
• Funds belonging to the nonprofit flow to the benefit of the for-profit company;
• Too small a portion of joint venture proceeds are obtained by the nonprofit;
• Too large a portion of the joint venture proceeds are obtained by the for-profit;
• The contract term is too long (e.g., five years); and/or
• Insufficient competition exists in the selection of the for-profit company.
Intermediate sanctions, part of the Internal Revenue Code, tax individuals, not organizations. While intermediate sanctions most often tax employees and volunteers associated with a 501(c)(3) or 501(c)(4) organization–or with an affiliate or foundation that has such status even if the organization does not–other individuals also may be taxed . Typically, this might include outsiders who have substantial influence over excess benefit and revenue-sharing transactions.
For example, suppose an association’s chief executive officer or one of its department directors negotiates a contract with a for-profit company for a joint venture through which the company earns $1 million. If the IRS determines that the outside company had substantial influence over the actions of the association in this venture, such that under normal circumstances the company’s earnings would have been only $800,000, then the excess benefit to the outside company–in this case $200,000–is the amount to which the tax applies.
The good news is that in this scenario the association is not taxed. The bad news is that the association CEO or department director may well be. While the outside company may be taxed at 25 percent of the excess benefit, for instance, the association staff members involved in negotiating the contract may be taxed at 10 percent of the excess benefit. Additionally, the tax applies for every year during which the challenged transaction remains uncorrected. In this particular scenario, that could mean that after four years the outside company may be taxed at 100 percent and the association staff members involved may be taxed at 40 percent.
How, then, can association staff and volunteers be certain that the organization develops and negotiates joint-venture agreements in ways that won’t expose them to intermediate sanctions? Heeding the bulleted points listed within the UCC section earlier in this article is a good start. In addition, individuals may get the benefit of a presumption of reasonableness if disinterested directors approve the transaction, and use comparability data, and document their work.
Uniform Computer Information Transactions Act
UCITA is the first federal law covering transactions involving computer information, and most often this will include e-commerce transactions. Virginia and Maryland have already passed UCITA, and many other states will do so by the end of 2001. Since UCITA is widely regarded as a vendor-oriented statute, participants in transactions covered by the act–such as an association contracting for a new Web site or other online ventures–will face a greater need for up-front legal planning.
At least part of this initial planning must include determining what changes to make to ensure effective warranty and liability provisions for the association, since guidelines provided by older laws will no longer apply. Careful analysis during early planning of the online venture will be all the more important because UCITA has its own list of mandatory, non-negotiable provisions.
In addition to UCC, intermediate sanctions, and UCITA, recent court cases have addressed taxation of royalty income from activities such as traditional affinity programs that have migrated online and electronic publishing and database ventures. The good news is that the courts have sided with associations claiming tax-free royalties. The bad news is that achieving that result without careful legal planning and drafting remains as tough as ever.
Likewise, the IRS recently reissued its regulations addressing the unrelated business income tax (UBIT) exception for sponsorship income. Commercial companies are increasingly interested in sponsoring the association’s activities, including those taking place on the Internet. The regulations limit the situations in which income from sponsorships can be tax-free.
And finally, the IRS issued a revenue ruling on hospital joint ventures that also applies to other exempt-organization joint ventures. That ruling emphasizes contractual control provisions in the joint venture. In essence, too much control by the commercial joint venture partner can endanger the tax-exempt status. The ruling suggests a three-part “safe harbor” test for associations to protect their exempt status. First, the dominant purpose of the joint venture should be one of the tax-exempt purposes of the association. Second, private or for-profit benefit must be merely incidental. And third, the association must have effective control of the venture.
Online Income Models
One easy way to classify strategic online partnerships is by the nature of the income the association will receive and what can be done to make that income tax-free. It is critical at the outset of evaluating an e-commerce proposal to realize that achieving tax-free income by accident is extremely unlikely. More and more during recent decades the IRS has administered UBIT as a tax that applies to almost all association income unless it is intentionally structured that income to fit within UBIT exclusion. Contrary to traditional thinking, the income is not automatically tax-free simply because the organization is tax-exempt. Here is an overview of the primary online revenue-sharing models.
Online partners may have the permission to use the association’s name and logo on its site in exchange for a royalty. Partners may be licensed to use information gathered on the e-commerce site for its own commercial purposes, in exchange for a royalty.
The organization may provide services and get paid a commission. That is generally considered taxable income. In many cases, the same activity would be better structured, legally and tax-wise, as a royalty. From a legal perspective, a royalty arrangement is preferable because the association would be considered as a passive licensor rather than an active participant in the business, thereby avoiding liability for legal claims against that business.
A royalty arrangement would also be better tax-wise because the royalty would be tax-free. However, as is evident by their associations’ contracts, many association executives do not fully understand that a commission cannot be made into a royalty by simply calling it that. First and foremost, the facts of the arrangement have to change.
A company may be authorized to sponsor a Web page, a Web-based educational program, or almost anything else in exchange for a sponsorship payment. If the sponsor does not receive a substantial return benefit, the payment can be tax-free. It must be realize, however, that large sponsorship payments often come with strings attached, so sponsorship regulations require careful analysis. For example, the IRS deals somewhat harshly with exclusive sponsorships in which the sponsor’s competitors are prohibited from providing their goods or services to the members.
Various agreements are being promoted by commercial companies to get charities involved in their online commercial ventures in exchange for making payments to the charities. These payments are sometimes characterized as charitable contributions. If someone pays money to a commercial company with the understanding and intent that a portion of it will go to a charity as a gift, that gift may be properly characterized by the charity as a contribution to the charity, and therefore be considered tax-free income. However, this isn’t always the case. If the charity provides services to the commercial company, for example, the IRS may classify the income as a fee for services. Each charitable partnership proposal requires individual analysis.
Business-to-business Internet marketplaces
Many associations are considering the online business-to-business model, initiated either on their own or with an outside partner. A vertical B-to-B marketplace automates procurement by bringing buyers and sellers together for transactions, and sometimes providing and/or gathering industry-specific information. A horizontal marketplace provides goods and services generic to many businesses, such as office supplies or business insurance. Internet marketplace relationships in particular give rise to several key issues.
• Taxation. Associations that run these Internet activities on their own can obtain several types of income, including fees for each consummated transaction. Absent a compelling argument that the service provided primarily benefits the public, such fees are likely to be taxable income. Associations that license their name and logo to a commercial marketplace operator, however, can collect tax-free royalties.
• Control. The do-it-yourself model permits more control than the licensing model. However, licensing agreements may provide quality control standards for the partner actually providing the product or service.
• Antitrust concerns. Either type of Internet marketplace raises substantial antitrust concerns (collusion and anticompetitive results) at the Justice Department and the Federal Trade Commission. These concerns are best handled while setting up the marketplace, by the way the marketplace is structured, and through specific provisions in underlying legal documents.
Migrating To The Internet
Some associations are migrating traditional activities to the Web. For example, publications are being moved online, as are affinity programs. What happens to the legal and tax issues surrounding these activities within an online context? The answer may be not much, or a lot. Not much happens if it is considered that a royalty is not changed to taxable income, or vice versa, by converting the member insurance affinity program to a Web-based marketing and application process. But a lot can happen if it is considered that new issues may arise that were less important, or even non-existent, prior to the migration.
Migrating an affinity program to the Web also raises a variety of legal and tax linking questions that will not be resolved anytime soon. For instance, is the link from an association site to an insurance provider’s site intellectual property that can be licensed for a royalty? Probably. Can a nonprofit, especially a Section 501(c)(3)or 501(c)(4) organization, give away the link–meaning permit the link to be used without charge? Probably not, because this could raise exempt-status issues, and for those two types of organizations, intermediate sanctions issues (taxation of individuals) as well. In addition, especially for charities, state attorneys general might object to diversions of charitable assets.
Why do organizations signing up for e-commerce sites so often strike out in the contract department?
Strike one. Association leaders sign standard contracts that take away the organization’s rights. And these contracts may reflect unintended legal relationships–for instance, the contract may describe the relationship as a partnership when it is actually intended to establish a licensor/licensee arrangement.
Strike two. Association staff negotiates their own contract changes rather than using a lawyer to negotiate the legal documents.
Strike three. The association does its own drafting rather than relying on legal analysis to figure out what laws apply, how to apply them to the contract, and how to integrate all parts of the contract. Out. When problems arise later, do not expect the contract for assistance.
In e-commerce, as in baseball, three strikes typically mean that ‘the player’ is out of the game. Failure to consider the complexities of old and new laws as they affect commercial activities on the Internet will reduce the income potential and increase the tax liability and other legal risk. Using legal counsel to help match the e-commerce activities with new legal developments–and to design and negotiate the customized contracts imperative in the new economy–will result in more income with less risk.
Reducing e-Commerce Risk
Because online ventures are for the most part still a new addition to the family of association strategic partnerships, the potential for legal and financial risk is very real. But associations can reduce their risk by keeping four things in mind:
1. A new person in the market is less likely to do something right the first time through. When the potential to make mistakes is recognized, one may slow down enough to ask more questions and seek more help, rather than trying to move ahead at Internet speed.
2. If the association is breaking new ground in the world of online ventures, recognize that the legal outcomes are less certain and potential dispute costs will be much higher, since no real legal precedence will be available on which to hang the hat.
3. In an online world, the number of potential plaintiffs who may want to sue is infinitely larger than in the pre-online world.
4. While Internet insurance policies are currently in the works, many traditional policies don’t explicitly state that they cover the association’s e-commerce endeavors. This itself should encourage associations to proceed cautiously in their online ventures.
Of course, careful analysis and development of any new venture early on will help reduce both legal and financial risk. To ensure that the association’s strategic planning includes strategic thinking about the online initiatives, be sure to answer certain key questions as an early part of a comprehensive e-commerce action plan:
• What new e-commerce activities are in the works throughout the association?
• What current e-commerce activities need legal review?
• What tax analysis has been done with regard to these activities, and what tax alternatives need more analysis?
• What budget steps must be taken before outside help is retained?
• Who should be on e-commerce planning team (e.g., senior information technology staff or consultant, insurance agent, lawyer, or certified public accountant)?
In view of the great importance of e-commerce, it is absolutely necessary to have adequate legislation. Such legislation must be adopted worldwide because the ease systems such as the Internet offer to the international trading of products or services, forces such transactions to be made in accordance with the trade law of each of the countries involved. The adequate legislation in each of the countries that perform electronic transactions will help the growth of e-business transactions.
In view of the fact that e-commerce is in a very early stage of development in many countries, there is no specific legislation in this respect. As electronic commerce is not mentioned in any Law or Regulation, electronic transactions are not considered as valid for any enforcement purpose at this time. Meanwhile, in many countries, in the absence of any specific legislation, parties may rely on private agreements to govern their e-commerce transactions. However, the agreements will not be enforceable unless they are in written form and signed by both parties.
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University/College: University of Chicago
Type of paper: Thesis/Dissertation Chapter
Date: 20 April 2017
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