High-tech firms facing VAT quandary

Date: 19/07/01

By Laurence Frost

AS COMPUTERS and Internet connections become ever-faster and cheaper, the day will soon arrive when the easiest way to consume music, video and software will be via a swift download onto a DVD. Such near-certainties underpin the forecasted boom in electronic commerce, which predicts sales to EU consumers multiplying by a factor of up to 10 over the next three or four years. But this is not quite the dream scenario it might appear to be for digital content providers this side of the Atlantic.

Europe's high-tech firms may be poised to take advantage of the new revenue streams, but the Union's legislation is not.

If nothing is done, the enormous growth of online services could damage EU firms, handing market share to foreign competitors. These firms, predominantly in the US and Asia, have two reasons to be cheerful - both related to the application of value-added tax (VAT) to online sales of downloadable goods. "If you're a private customer in the EU you can download services from outside Europe without paying VAT," explains Gerhard Huemer, tax expert at small business association UEAPME. Smaller firms make up the large majority of software providers in Europe. "The second problem is that when a non-EU customer is buying from an EU company, that company has to pay VAT in its own country," Huemer adds.

Whether the customer is inside or outside the bloc, an EU firm is at a cost disadvantage to foreign firms of between 15% and 25% on each sale, according to the VAT rate in place where they are established.

Something is being done, but progress is slow. In June last year, Tax Commissioner Frits Bolkestein tabled a proposal to lift the levy on sales by EU firms to customers outside the bloc, while compelling third-country firms to pay the tax on their sales within the Union. But the initiative foundered during the French presidency because it would have allowed the country in which a foreign company chose to register to take the VAT receipts for all of the firm's EU sales - an arrangement which was supported only by low-taxation Luxembourg.

A year later, EU governments are closer to consensus, with the UK alone blocking the compromise on the table.

According to the complicated plan, foreign providers would still register in one member state, but the VAT rate paid on each sale would vary according to the customer's location, with revenues being passed on to his or her government. Smaller firms want to see the plan approved, but concede that some of London's concerns over the workability of the proposed legislation are valid. "I'm not very optimistic," says Huemer, "because the compromises on the table now are so complicated that the British have good reason to say no."

But media conglomerates are backing a call by the UK for an international deal at the Organisation for Economic Cooperation and Development (OECD). Online service blue-chips fear they would otherwise have to play by EU rules which could not be enforced on the many smaller firms in the global sector. Also, they fear an international fragmentation of approaches to the problem. "If we have a solution at EU level, other regions will adopt their own solutions which won't necessarily be the same," says Guido De Wit, chairman of the VAT working group at the American Chamber of Commerce. "This could lead to double taxation or non-taxation because of potentially conflicting rules."

The big firms argue for an international framework to thrash out the kind of details dealt with in the earlier OECD-led drive to tackle overlapping income tax rules. Meanwhile, they back the UK's call for a complete moratorium on VAT for online services. But De Wit doubts whether Britain can continue alone to obstruct the Swedish-brokered compromise which was discussed at June's meeting of finance ministers - just days before the UK's general election. "I don't have a crystal ball, but what's being said in the corridors is that now [the election] is over, the other 14 could perhaps persuade the UK to accept it."

Feature looks at the issue of the application of VAT to online sales of downloadable goods. Article forms part of a survey on e-commerce.