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HM Customs and Excise has signalled that it is keen to create a "level playing field" on tax matters for ISPs operating in the UK.

The comments come as the row over a tax loophole that allows non-EU based ISPs to operate without paying VAT (Value Added Tax) took a new twist this week when Freeserve threatened to sue the British Government unless the matter was resolved swiftly.

HM Customs has carried out a review of the matter since the summer and has passed on its recommendations to Treasury ministers.

Officials are unwilling to comment on the exact nature of its recommendations, but a spokesman for HM Customs The Register that the UK has made "every effort to persuade its European Union partners of the need to treat packaged services uniformly for place of taxation purposes".

"However, the agreement of all member states has not been obtained but we are committed to making a level playing field on this issue," he said.

While ministerial approval still needs to be sought, it seems likely that Freeserve - which has lobbied hard for a change in the tax law - will be heartened by the tone of the statement.

However, the whole matter of indirect tax liability is devilishly complex and difficult to understand.

Five years ago the Internet Service Provider's Association (ISPA) lobbied hard for a change to European tax rulings.

Some American companies had claimed that they did not have to comply with European Union indirect taxation legislation as their services originate in the US.

ISPA lobbied the Commission, arguing that this created an unfair situation with US companies effectively having a 17.5 per cent competitive advantage over European ISPs.

In 1996, Shez Hamill, the then ISPA Chairman, said: "Such a loophole in the system cannot be allowed to continue.

"Either it will mean that US companies will make enormous profits, or they will undercut prices to increase market share which could put our smaller Internet Service Providers out of business," he said.

ISPA's lobbying did help to close the tax loophole for business-to-business operators, but not for business-to-consumer operations, such as AOL, operating outside the EU.

ISPA has now written to HM Customs to seek clarification.

In October a report by investment bank Merrill Lynch claimed that the "biggest challenge to AOL UK remains the possibility of losing its VAT-exempt status in the UK".

The report claims that if this happened it would "either result in an immediate 17.5 per cent drop in margins or necessitate a price increase of the same amount (which would likely weaken the company's competitive position)".

The report continues: "While it is not for us to comment on the legal minefield as it exists today - and, therefore, the outcome of the VAT issue - we would probably agree with the ex-MD of AOL UK, Jonathan Bulkeley, who said in 1996 when asked in an interview with ZDNet 'What about VAT. Many smaller ISPs claim that you should pay VAT?' He replied: 'It'll happen at some point. It could be five years from now. We'll live by the letter of the law.'"

The Merrill Lynch report concludes: "That five years is now up."

It's hoped that a decision by Ministers on the matter will be made by the end of the year, although it's possible it could be delayed until into 2002. ®

Related Stories

Freeserve threatens legal action against UK Govt
Freeserve tackles AOL UK over '£2.5 million in unpaid VAT'
AOL UK escapes £1.8m in tax in 22 days
'If AOL UK paid full VAT it could fund heart transplants'
Freeserve takes swipe at AOL's tax free status
Freeserve threatens to move operation to Algeria

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