Europe 's value-added tax now applies to a new class of Internet products. It's making life more complicated for a host of U.S. companies.


DOW JONES NEWSWIRES: Government bureaucrats are forcing some U.S. Internet companies that have never collected sales tax to do exactly that. But these bureaucrats aren't in Washington . They're in Brussels .

On July 1, a new European Union law went into effect requiring non-EU companies to levy the value-added tax on fees paid for Internet service, as well as for products downloaded by customers in Europe over the Internet, including software, music and videos. The VAT varies from country to country -- as high as 25% in Sweden to as low as 13% on the Portuguese island of Madeira -- and is often factored into prices, so consumers don't even know they are paying it.

As a result of the new law, not only will a buyer in Europe have to pay the VAT on a product bought on eBay Inc.'s online auction service, but the EU sellers will have to pay the VAT on the fee they pay eBay to list their products on the site. More important, U.S. Internet-service providers will be charging customers a tax for the first time .

Given the size of the Internet-service market in Europe , that could eventually result in a significant source of tax revenue for EU countries. As of June 2003, there were 169 million users of Internet services such as Time Warner Inc.'s America Online. And while sales of downloadable goods at the moment make up a small portion of the multibillion-dollar Internet sales market , industry experts predict that will change when consumers get used to being charged for downloading music and films.

So far, e-commerce experts say, well-established U.S. companies are complying with the new VAT rule, fearing that EU authorities would easily spot them because of their large sales in Europe . Large U.S. companies with millions in revenue from Europe , such as AOL, also don't want to risk running afoul of EU officials. They are also large enough to be able to absorb the VAT themselves, to avoid charging their customers the tax.

But small online retailers are struggling to comply with the arcane tax system , and some don't even bother, hoping they're too small to show up on the radar of London and Paris tax authorities.

The Debate Continues
In the U.S. , e-commerce companies only have to pay taxes on physical products shipped to states where they have physical operations or stores. In Europe , anything bought on the Internet by European consumers is subject to the VAT, whether the seller has physical operations there or not.

The new tax rule stems from European companies' call to level the e-commerce playing field. By not having to pay the VAT, European companies argue, their U.S. competitors have had an unfair advantage.

Getting Your Due: Each year, tourists and businesses leave behind billions in unclaimed refunds on value-added taxes. Read a primer on VAT.

But U.S. authorities say the new rule discriminates against U.S. companies without European operations. European companies and U.S. companies with European subsidiaries can use a single country's rate based on where their headquarters are. They don't have to determine where their customers live so they can charge them their home country's VAT, so they avoid costly and time-consuming red tape. In contrast, U.S. companies without a European unit have to follow 15 different VAT regimes, and that will increase to 25 as the EU adds members from Southern and Eastern Europe next year.

Some large U.S. technology firms, such as Inc., eBay, and AOL, already had a European presence and started charging the VAT rate according to where their affiliates are based. had already been charging VAT for retail sales, including books and compact discs, in Europe based on where the customer lives . Starting July 1, the online retailer, through its Luxembourg subsidiary , began charging VAT on the fees sellers pay to put up products for sale on the Marketplace, Auctions and zShops portions of its Web site. Meanwhile, for the e-books it sells through EU affiliates, it charges the VAT based on where the customer is, because those affiliates are run by the U.S.-based International Sales Inc.

AOL, which previously wasn't forced to charge VAT on its U.K. sales, responded to the new law by expanding an existing Luxembourg office to benefit from the country's relatively low 15% VAT rate. Before the new law, AOL's affiliate in France , which is considered a French company, was subject to VAT in France and Germany , but not in the U.K. That's because it was classified by U.K. customs officials as an information provider -- with its hub out of the U.K. -- not a provider of telecommunications service, which is taxable.

Absorbing the tax will cost AOL's European operations up to $60 million in the second half of this year, says a spokeswoman for AOL. "We factored VAT into our planning, and AOL Europe is still on track to break even in 2004," she says.

Meanwhile, eBay says it started collecting VAT from sellers in Europe , after installing new computer programs to add hefty costs to the fees those sellers pay to sell on its auction sites. Kevin Pursglove , a spokesman for eBay , says it's too early to give precise figures on how the tax has affected eBay's bottom line, but so far the impact appears minimal. "There's normally a run-up in listings a week or two before [a new fee], and then a slight drop off afterward," Mr. Pursglove says. "After the third or fourth week , listings return to normal as people get used to it."

It's Not Easy Being Small
But it's a different story with small companies, many of which are likely ignoring the tax. Some may not know about the rules; others may figure they're not taking a big risk flouting the law. That's because, as in the case of most attempts to regulate e-commerce, the EU has yet to work out the mechanics involved in monitoring online companies' VAT compliance.

For those small companies that want to expand in Europe and need to follow the rules, though, the VAT is a huge administrative headache. They often don't have the resources to set up a European subsidiary to be able to charge one VAT rate, nor the know-how to overhaul Web sites to account for the different rates, and then start collecting, reporting and distributing the VAT.

"For a small company it's not something that's easy to absorb, and it could be passed on to the customer," says Christopher Allen, senior vice president of marketing of San Diego-based software maker Musicmatch Inc. "That could affect our sales," he says, although he can't specify how much. About 20% of sales are international, and the company has been working for months with a tax consultant to make sure it can sell its music program, Musicmatch Jukebox, in Europe .

In Alpharetta , Ga. , Bill Adler, chief executive of CyberScrub LLC, has worked overtime to avoid customer sticker shock in Europe . The company has developed new administrative and tax-collecting procedures and opted to absorb the costs. Otherwise, customers in Europe will see a surge in the prices of the company's product, which permanently erases files from hard drives . "If you want to compete, you don't want to have extra charges," says Mr. Adler.

He predicts that small U.S. e- tailers that simply add the tax to their digital products will soon see cyber customers slip away. "Sales at many small companies will grind to a halt," he says.