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Luxembourg and France must stop applying a reduced VAT rate to electronic books because doing so distorts competition across the rest of the EU and is in breach of EU tax laws, the European Commission has said.

The Commission said it had issued both member states with "reasoned opinions" formally requesting that countries change their VAT rules around ebooks within one month to comply with EU law. Countries that do not comply with the requirements of EU law can be referred to the European courts. The Court of Justice of the European Union can order EU member countries to implement EU Directives and fine them if they do not.

While the Commission acknowledged that there is "different treatment" given to the way that printed books and e-books are subject to VAT and said that it would outline plans on the issue before the end of next year, it said that "as guardian of the treaties" it was duty bound to require member states to "respect the [existing] VAT rules they themselves unanimously approved".

"This dispute illustrates the difficulty in creating a single consistent VAT regime across the single market," said tax law specialist Ian Hyde of Pinsent Masons, the law firm behind Out-Law.com. "If there are VAT differences between member states or between different routes to market then it will distort business behaviour. New rules – and new products – create anomalies. Another example is how the low value consignment relief encouraged businesses to sell CDs into the UK from the Channel Islands."

"The EU is seeking to correct the ebook anomaly by making Luxembourg increase its VAT rate on ebooks. This will help other ebook suppliers in the UK by removing the benefit in routing sales via Luxembourg but it does nothing to address the bigger anomaly: why are ebooks subject to VAT when printed books can be zero-rated?" Hyde said.

The Commission said that France and Luxembourg had applied a reduced VAT rate on ebooks since the beginning of this year, but said that those arrangements were "incompatible" with existing rules set out in the EU's VAT Directive.

"Under the Directive, ebooks constitute electronically supplied services, and application of a reduced rate to this type of services is excluded," the Commission said in a statement. "This situation is creating a serious distortion of competition to the disadvantage of operators in the 25 other Member States of the Union, as e-books can be easily purchased in a Member State other than that in which the consumer is resident, and current rules provide for application of the VAT rate in the Member State of the provider rather than that of the customer."

"The Commission has received complaints from a number of ministers of finance highlighting the negative effect on book sales in their domestic markets," it added.

The Guardian newspaper has reported that Luxembourg has been asked to apply a 15 per cent VAT rate to e-books instead of the 3 per cent rate it currently levies. It said that Amazon, which controls about 90 per cent of the e-book retail market in the UK, asks publishers to absorb a 20 per cent VAT rate as part of the deal for Amazon selling their e-book titles in the UK whilst it only has to pay 3 per cent VAT because it supplies the goods from Luxembourg where it is registered. France levies 7 per cent VAT on e-books, according to The Guardian's report.

Amazon did not respond to our request for a comment.

Copyright © 2012, Out-Law.com

Out-Law.com is part of international law firm Pinsent Masons.

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