Cooking Up An E-VAT?

By James Graff/Brussels

A Spanish fan downloads the latest Prince album from the artist's U.S.-based website. A Swedish schoolboy has his mother buy him a Japanese Pokemon game online. An American expatriate in London orders personal-finance software from the U.S. O.K., class, question: Where should the sales tax go?

In most of the world today, the answer is "Nowhere." Almost every government in the world, following the lead of the U.S., refrains from taxing the Internet, for fear of stunting the world's most exciting new commercial medium. But the honeymoon may soon be over. In Europe, Luxembourg may be about to become the first cornucopia of Web sales taxes--at least if the European Union's executive body, the European Commission, has its way.

Last month the commission issued a directive calling for value-added tax--the consumption levy that provides 44% of the E.U.'s budget--to be collected from non-E.U. firms that sell "Internet-based services" to anyone in the 15 member states. (The measure must be endorsed unanimously by all 15 member states to become law.) Under the proposal, a firm selling more than $100,000 or so worth of software, games, prepaid television or music a year for electronic delivery in the E.U. would be obliged to register with one of the 15 member states' tax authorities and levy VAT on all European online sales. Because Luxembourg has the lowest VAT rate in the E.U.--15%, in contrast to as much as 25% in Sweden and Denmark--the Grand Duchy would be the obvious place for corporations to register their sales--and it would hence reap the tax revenues.

The directive aims to create that most subjective of trade goals, a level playing field. As matters stand, European companies operate at a disadvantage on the Web. E.U. regulations force them to charge VAT to their customers wherever they are located; non-E.U. firms do not force consumers to pay the tax anywhere. Brussels has been under pressure from member states and European content providers to correct that obvious flaw in the tax regime. (Revealingly, the commission did not propose adopting the non-European practices.)

The latest proposal, however, may present as many problems as it solves. U.S. Deputy Treasury Secretary Stuart Eizenstat voiced "serious concerns with both the substance and process" of the directive, arguing that "the unintended implications of the...proposal are not worth the short-term tax revenues that may result." Among other things, he said, the new law could result in a higher tax on books delivered online than those bought in a bookstore. Ken Wasch, president of Europe's Software & Information Industry Association, called the directive "simply unenforceable." Guido de Wit, a VAT tax expert with a Brussels law firm, notes that the commission intends to use credit-card billing addresses in chasing tax revenues. That, he observes, is likely to run afoul of credit-card companies that want no part in releasing information for tax purposes. Nor is it at all clear how European tax authorities could audit the flow of international e-commerce or sanction those that don't levy the tax.

Unanimous E.U. approval of the controversial measure is unlikely, at least without substantial changes. But the important thing is that Europe is making the first attempt to grasp the nettle of taxing an increasingly intangible economy. It won't be the last. --By James Graff/Brussels