Europe and US scramble to close Internet tax loophole

A big Internet tax row is brewing as authorities in Europe and the United States scramble to close loopholes in the system which enable Internet users to make some purchases tax-free.

Under existing regulations, private individuals who buy services on-line are not liable to pay either duty or VAT. One problem area is computer software which can be bought free of tax if down-loaded on-line.

Tax authorities are becoming increasingly concerned that the loophole could cost fiscal authorities millions of pounds in lost revenue. Retail sales on the Internet totalled only $500m last year but are predicted to rise to $6bn by the end of the decade. Computer software is also one of the most popular items sold on the system. The problems could worsen as technological advances will soon enable music, video and books to be down-loaded on-line. These, too, could be sold tax-free as they would constitute a service and not a physical good.

The crackdown has angered Internet service providers and some retailers who feel that draconian taxes could kill the Internet before it has the chance to get off the ground.

In Europe, the European Commission is conducting an urgent review of the effects EC law has on the Internet. In the US, some states are already trying to introduce taxes on Internet sales. Florida's Department of Revenue is trying to introduce legislation that would see customers pay a 7 per cent service tax while the service provider would be subject to a tax of 2.5 per cent of total revenues.

There are concerns that if some states try to level sales tax on goods, then vendors will move their operation to a state that does not have sales tax, or move the business off-shore. Some retailers have said that if the taxes were too harsh they may not bother selling electronically at all.

In a separate tax development, plans by Customs and Excise to impose a three-year limitation on value added tax refunds and repayments are being greeted by increasing hostility in the business community. The comments were made by a delegation of VAT experts from the big six accountancy firms to VAT Commissioner Martin Brown and senior Customs officials yesterday.

The plans follow a series of defeats for Customs in VAT cases, culminating in a ruling - estimated to have a potential cost to the Exchequer of pounds 5bn - that it had wrongly charged the tax on "interest-free" credit deals since it was introduced in 1973.