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BRUSSELS--European finance ministers have agreed on a regime for collecting value-added tax on online sales of digital products such as software and services such as Internet pay-TV.

Under the agreed system, companies outside of the European Union must pay the VAT rate in the country where their customers reside, through one portal country of their choosing. That country would then pass on the VAT of the consumer's country.

The regime covers only business-to-consumer transactions. Around 90 percent of e-commerce sales are business-to-business transactions and these are covered by separate rules. At present, most U.S. firms don't add VAT on consumer transactions with EU customers.

The new laws "are not discriminating against non-EU companies," said Rodrigo Rato, Spain's finance minister and chairman of Tuesday's finance ministers meeting.

Firms within the EU that sell digital products or services over the Internet will continue to pay VAT at the local rates in their country. Some countries, including the U.K., have not charged VAT in the absence of any EU ruling.

Under the new laws, EU companies selling to consumers outside of the EU will be able to do so VAT-free. This will "remove a major competitive handicap" on European firms competing on the world market, said Frits Bolkestein, commissioner in charge of the internal market at the European Commission. His staff drafted the new laws.

Now, a U.S.-based software company will have to add 25 percent onto the sales price of its software if its consumer is in, say, Sweden. A rival company based in Luxembourg need add only 15 percent to the price for the same customer.

This is because the EU company would pay the local Luxembourg VAT rate, the lowest in the EU, while the U.S. competitor must pay the highest VAT rate in the EU--that charged by the Swedish government.

U.S. Objects

The U.S. government said the new laws, which will come into effect by July 2003, discriminate against small U.S. firms that do not have a presence in the EU. Deputy U.S. Treasury Secretary Kenneth Dam said the Bush administration will try to convince the EU during talks at the Organization for Economic Cooperation and Development that the rules are unworkable. The OECD is trying to find a global consensus on taxing e-commerce. If that fails, Washington may lodge a complaint at the World Trade Organization, Dam said.

The U.S. Diplomatic Mission to the EU said Tuesday that the position expressed by Dam has not changed.

The U.S. made the same threats in 1997 when VAT was imposed on non-EU telecommunication providers competing on the European market, said one EU diplomat. "The U.S. government would be naïve to think it can launch a complaint at the WTO," she said.

The laws, one a directive and one a regulation, call for a review of the e-commerce VAT regime three years after the laws take effect. The U.K. government got backing for the idea of an online VAT payments system for all Europe. Details of this idea remain sketchy. The ministers agreed that such a system could take over from the regime adopted Tuesday at the end of the three-year period.

"I am delighted that the Council of ministers has at last been able to agree the important directive on applying VAT to digital products," said Frits Bolkestein, commissioner in charge of the internal market at the European Commission. His staff drafted the laws. "This measure will remove the obligation for EU firms to apply VAT when exporting to world markets."

The law brings business-to-consumer rules in line with existing laws governing business-to-business e-commerce, which accounts for 90 percent of all Internet transactions, the European Commission said.

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