EU closes AOL UK VAT loophole (but not yet)

AOL will have to start charging UK customers VAT - from July 1, 2003, bringing it into line with British ISP rivals.

The change follows a policy review conducted by HM Customs & Excise, the British government arm responsible for VAT ruling and collection.

Currently, AOL UK is treated as a content provider domiciled outside the European Union, and therefore not subject to VAT, unlike UK competitors, which are treated as telecoms providers (and therefore subject to VAT). This ruling is estimated by Freeserve, the UK's biggest ISP, to save AOL £30m a year, and gives its rival a huge unfair competitive advantage.

In a Business Brief, published on March 14, HM Customs largely appears to endorse this viewpoint. But the authority argues that "differences in the current VAT treatment of such packages are a direct function of existing EC provisions, which fail specifically to cover packages of Internet service and content.

"A lasting, fair and clear approach, whereby all Internet service packages supplied by UK and non-EC ISPs are taxed in a similar way can only, in Customs' view, be successfully achieved through material
changes to the relevant EC VAT rules."

Such a change is underway with changes on treatment of VAT contained in the EU's new e-commerce directive, HM Customs says. This will see the determination of VAT charging on certain services - "including digitalised products, and so content provision" - move from reference to the location of the supplier to reference to the location of the consumer. The upshot is that the ecommerce directive, a very controversial ruling - especially with the US government and US-domiciled online retailers, catches AOL UK on the content provision front.

So what now? There will be a level playing field for all ISPs operating in the UK, but only from July 1, 2003. Will this note be enough to fend off legal action from Freeserve, which has applied for a judicial review of HM Customs' treatment of AOL? Considering that AOL will stand to profit to the tune of £40m until the ecommerce directive comes into force, we suspect that Freeserve will continue to argue its case in court that HM Customs is wrong. ®