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EU Stirs Up Internet Sales Tax Debate
Value-Added Tax Could Provide Ammunition for Supporters of Taxing E-Commerce in the United States

By Brian Krebs
washingtonpost.com Staff Writer
Monday, June 9, 2003; 6:29 PM

The term "laissez-faire" comes from France, but it's the United States that has applied the economic term in its purest sense to business on the Internet, banning Internet-specific taxes and dragging its feet on taxing e-commerce retail sales.

Europe's latest economic policy export isn't getting such an enthusiastic embrace from the American lawmakers and the business community .

On July 1, the 15-nation EU will begin collecting the VAT, or value-added tax, on sales of digital goods and other electronic transactions from U.S. and other non-EU companies. This means that American companies selling downloadable music, movies, games and software to customers in the EU might have to collect taxes that could boost the total cost of their products in Europe by as much as 25 percent.

For companies like America Online and Internet auction giant eBay, it means additional costs for restructuring their European operations, as well as possible price increases for their customers.

For the U.S. business community, it presents a radically different philosophy on taxes. VAT is one of the EU's primary revenue sources, and online consumer sales in the union always have been subject to it. In the United States, however, building a consensus on taxing e-commerce sales has proved far more difficult. More than 30 states are collaborating on an Internet sales tax framework, but the hurdles to putting it in place are numerous. While some major Internet retailers are collecting sales taxes, they remain the exception rather than the rule.

If the EU is successful in requiring VAT collection by American firms, observers say it could set an important precedent for taxing Internet commerce in the United States.

"Governments from South America to China are looking to Europe as the source of the latest in regulatory innovations," said Gary Litman, vice president for Europe and Eurasia at the U.S. Chamber of Commerce. "I can see a lot of countries looking abroad and saying, 'If Brussels can regulate this, why can't we?'"

Jonathan Todd, a spokesman for the European Commission, agreed. "Some of the opposition to this measure appears to be driven by the fear that it could serve as a precedent for taxing e-commerce within the U.S.," he said.

The EU's decision to tax digital sales from all over the world is born of a desire to tax e-commerce companies equally. American companies now enjoy a price advantage over EU-based businesses because they don't have to pay VAT, the EU says.

U.S. businesses say VAT will put them at a disadvantage because they either must comply with 15 different tax codes, or establish a European office. European companies, by contrast, only charge the tax rate of the country where they are located.

E-commerce companies in the United States have been reluctant to open up their coffers to state taxes, but many of them already are complying with the new EU rules. Last week, online auction giant eBay Inc. said it would start charging its sellers VAT to comply with the new regulations. The company in its annual report said the change could slow the expansion of its fast-growing international unit, which accounts for nearly 30 percent of its sales so far this year.

American companies have two general options for complying with the VAT. They either can register their business and set up a headquarters in one EU country, and pay that country's tax rate. If they do not set up a physical headquarters in Europe, they would pay the tax rate for the country where the customer lives -- ranging from 15 percent in Luxembourg to 25 percent in Sweden.

Dulles, Va.-based America Online said last month that it would move its European headquarters to Luxembourg. The move, which included a significant expansion of its office, major technological changes and the addition of two dozen new employees, was costly, a spokeswoman said, but beat the alternative of complying with 15 tax codes.

"Doing nothing just wouldn't be a viable option for us," said AOL International spokeswoman Mia Kulla.

AOL officials would not comment on how much revenue will be up for taxation. The company has more than 6 million subscribers in Europe, and most of them pay the equivalent of $24 a month for Internet access -? an estimated cost of $22 million per month under Luxembourg's VAT. Despite the added tax, the company does not plan to immediately raise its monthly service fee.

Amazon.com said it plans to charge VAT on the commissions it collects for hosting its online auctions. The company also will collect the tax on sales of downloadable software and e-books, a spokesman said.

Processing VAT receipts is one thing for large firms experienced in working across borders, but smaller Internet retailers will have more trouble adjusting to the new system, said Mark Bohannon, senior vice president of public policy at the Software & Information Industry Association.

"There's a distinct possibility that non-European businesses are going to be dealing with a lot of confusion on July 1," he said.

Some businesses simply will ignore the shift, either because they figure they cannot be prosecuted or because they won't know that the system has changed, said Peter Merrill, a partner at PriceWaterhouseCoopers.

Another difficulty U.S. businesses say they will face is verifying a customer's identity. Sophisticated Internet users can mask their locations in order to escape paying sales taxes or make it look like they live in an EU country with a low VAT rate.

"There is a great concern that if a customer lies to you ... that EU governments are going to make vendors pay the tax themselves, leaving the vendor with virtually no ability to go after the buyer," Merrill said.

The debate has attracted the attention of the Bush administration, which has said that subjecting U.S. and European companies to different tax schemes could amount to an illegal trade practice.

"We have to consider not just how the VAT plan will affect us today, but also how will this impact where U.S. businesses will want to go in the years ahead," a senior Treasury official said last month in an interview. "At this point, the [VAT directive] looks like it could put a crimp in those plans."

In a letter last week to U.S. Trade Representative Robert B. Zoellick, a bipartisan group of a dozen House lawmakers urged the White House to challenge the agreement before the World Trade Organization.

"These remain challenging times for many American Internet companies," wrote Rep. Cliff Stearns (R-Fla.), chairman of a House trade panel. "They are fighting hard to make their businesses work and to reach global markets, thus helping drive the American economy. We ask that they be given a fair chance and a level playing field."

In the end, the EU's application of VAT to Internet sales could amount to a welcome trojan horse for states already pursuing a national Internet sales tax plan.

"Companies will have to put in place procedures and software to implement VAT, and once they've done that it's relatively easy to do the same in the U.S.," said James Lewis, director of the technology and public policy program at the Center for Strategic and International Studies. "The states who want to tax e-commerce can point to the EU experiment. The big Internet companies will have changed how they operate to make it easier to implement VAT."

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