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By Robert MacMillan
Washtech.com Tech Policy Editor
Tuesday, May 7, 2002; 2:30 PM

The European Union next year will begin collecting the "value-added" tax (VAT) on digital products sold via the Internet, following the European Council of Ministers' formal adoption of the plan today.

Companies based in E.U. member states and in the United States will be required to collect the tax starting July 3, 2003, prompting outrage from both the Bush administration and business groups in the U.S.

The move brought immediate criticism from several U.S.-based trade groups, including the National Association of Manufacturers (NAM), which claims that the tax regime discriminates against U.S. businesses, and that it is difficult to enforce properly.

"Needless to say, we're extremely concerned about tax collection duties on U.S. companies," said Kimberly Pinter, who handles tax issues for NAM. "There normally isn't a reliable way to tell where your customer is."

"We continue to be concerned about the potential for discrimination inherent in the new E.U. VAT regime that applies to downloaded products," said Treasury Department spokeswoman Tara Bradshaw. "The regime may discriminate against non-E.U. companies in terms of the tax rates required to be charged and the administrative and compliance burdens, and may discriminate against e-commerce more generally." Under the plan, companies doing business in the E.U. would be required to register in one country as their headquarters. They then would collect the VAT rate of the country in which they registered, but hand over the revenue to the country where the customer resides.

The VAT would apply to all products sold on the Internet, as well as products used online, such as digital music or books. The VAT also would apply to goods and services that E.U. citizens and companies buy from businesses operating in the U.S. and other countries.

The new system would not require E.U. businesses to charge the tax when selling products to people or companies in markets outside the union.

Questions remain, however, about whether a person who says they live in, for example, Germany, actually lives there. Critics of the plan say that just because someone's e-mail address features a "dot-de" domain does not mean they live in the Federal Republic.

The Information Technology Association of America (ITAA) said that non-European vendors - mainly those in the U.S. - could lose valuable time trying to verify the customer's location to compute the VAT they are supposed to levy.

The 15 E.U. member states sport a variety of VAT rates, from as low as 15 percent in some countries to as high as 25 percent in others.

European Union First Secretary for Trade Matthew King said that it is possible that e-commerce companies doing business in the E.U. will gravitate toward countries with lower VAT rates, such as Luxembourg, but that there are many other reasons besides low VAT to set up shop in various countries.

Administration officials say the program could violate World Trade Organization rules, hinting at a possible trade dispute, though the E.U. claims the VAT is consistent with the Organization for Economic Cooperation and Development's rules.

An official with France Telecom, who requested anonymity, said that the company supports the VAT measure.

"We agree with the principle of taxation at the place of consumption, which this directive advocates," the spokesperson said, adding that France Telecom has worked with other companies in the European E-Business Tax Group to develop the plan with input from Cisco Systems, Compaq, Deutsche Post, General Electric, Hewlett-Packard, IBM, Microsoft, Vodafone, Siemens and Sony.