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AOL's UK business - which doesn't pay VAT due to a loophole - is to start paying the tax indirectly via a new centralised European company from July 1.

The UK ISP intends to absorb the tax hike and has no plans - at the moment at least - to pass on the charge to its UK customers.

The move follows a decision by AOL to set up a new company - AOL Europe Services SARL - in Luxembourg that will provide all of AOL's services in Europe.

Under the new set-up, all of AOL's European customers will be billed by the Luxembourg operation. As a result the company will be able to charge a single rate of VAT across all of its country operations, instead of charging different rates of VAT based on each individual country's tax laws.

The move to centralise AOL's European business has been timed to coincide with the introduction of new European tax legislation, which comes into force from July.

By establishing a central operation in Luxembourg, AOL claims it will lead to lower administration and network costs for its European business.

An office employing around 25 people has already been set-up in Luxembourg alongside a new network operations centre (NOC).

Details of the move were contained in an email to AOL UK subscribers yesterday.

In the email Tony Hanway, VP Member Services, he said: "On 1st July 2003, the contracting party responsible for the supply of the AOL service (whether broadband or narrowband) and for the proper treatment of your personal information will be changed to another company within the AOL group, AOL Europe Services SARL.

"From 1st July, this company will be contractually responsible for the provision of the AOL service to you in place of the current supplier, America Online Inc.

"We are taking these steps to allow AOL to continue to provide services across Europe efficiently and cost-effectively," he said.

AOL UK has received a lot of stick in the past - predominantly from rival Freeserve - over the tax loophole that exempts it from paying VAT in the UK. In September 2002 Freeserve estimated that AOL UK had avoided paying around £40m in VAT due to the exemption. It made the claim as it was given the green light to challenge an HM Customs and Excise decision not to charge VAT on AOL's Internet service in the UK.

However, the judicial review has now been delayed until October 2003 because a key witness is on maternity leave. ®

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