US beats us on VAT

British firms could lose out because of a tax loophole, says Malcolm Wheatley

Government policy is actively pushing potential Net surfers towards American service providers rather than British ones. The reason is a bizarre VAT loophole that sees US or other non-European Union companies excused the need to charge their customers VAT. As the online market becomes more competitive, the 17.5 per cent differential may be enough to squeeze British firms out of the market altogether. It is a bizarre and confused situation.

The confusion starts with users. When filling in my VAT return, I started to wonder about the lack of appropriate VAT documentation I had on my longstanding CompuServe account. For years I had assumed that my payments to CompuServe's online service included an element of reclaimable VAT. Despite the fact that CompuServe itself is American, I live and work as a journalist in the UK, and my dealings with CompuServe are through its offices and support personnel in Bristol and Reading. The VAT manual was absolutely clear: despite the fact that I had no VAT invoice - as the monthly payments are debited from my credit card - the commercial relationship was obviously VAT-able.

My local VAT office told me to call CompuServe. "We don't charge VAT," said a company representative when I called to obtain its VAT number and an official invoice. "We'll check," said the VAT official, and rang back later to confirm that yes, the company should be charging me VAT. "Oh no we shouldn't," said CompuServe.

I checked the pricing structures of other service providers. They did charge VAT. CompuServe said it did not. So what should I put on my VAT return? Time was pressing. "It's because we're American," said Martin Turner, head of marketing at CompuServe. "I'm not a tax lawyer, but our customers' contracts are not with the UK end of our business, but with our parent company, CompuServe Inc, in Columbus, Ohio. That's where the main computer systems are, too."

But what about the definition of a VAT-able service contained in the VAT manual? He said he'd get a tax expert to telephone me with a more exact explanation - so far, no one has. However, he refuted any suggestion of unfair competition. "We are a credible and reputable company and play straight, with a straight bat."

Other service providers were equally puzzled. Richard Nuttall, director of business development at Unipalm, the Pipex service provider, said: "Of course we charge VAT." There were anomalies within a European context - European users can claim back any VAT they were charged by Unipalm, for instance, but he couldn't see any reason for not charging VAT at all.

Neither could Jennifer Perry, director of sales and marketing at the fledgling service provider UK Online - which, unlike Pipex, targets individual consumers more closely. "Yes, we charge VAT," she said. "We have to. We'd love to know how CompuServe manages to get away without charging it."

By now, so did I. I rang Customs & Excise again, this time the press relations people in London. At last, an answer - after Mark Thompson, a spokesman, had burrowed in the files for a couple of days. "It's all to do with the Sixth Directive," he said. "It's rather out of date - the problem is that all countries involved can't agree on a solution. Meanwhile, there are telecommunications anomalies like this."

Like what? Well, Article 91, to do with the place of supply of taxable services, apparently states that services are taxed based upon where the services originate from - something now "recognisably out of date in the telecommunications era". So services originating in the UK or anywhere else in Europe are obliged to charge VAT.

Services that originate outside the EU altogether, however, aren't required to charge VAT. This opens up a loophole - to the detriment of potential UK service providers, and the UK economy, which is deprived of tax income. So until the loophole is closed, should businesses wanting to market Internet services to UK consumers do it from overseas? "In the short and medium term, yes," Mr Thompson agreed. "This won't be sorted out quickly. In the longer term, though, no. The anomaly will be resolved in time."

But the short to medium term is good enough for Bill Gates. I called Microsoft to ask about its Network. "We won't be charging VAT," Jeremy Gittins, product manager, told me. "We haven't been required to."