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Until now, thanks to the lobbying efforts of online retailers and an Internet-friendly Congress, the Internet has been a relatively tax-free shopping zone. But like pets.com’s sock puppet, this built-in government freebie may soon become one more quaint relic of a bygone age. The threat is not coming from this country, where a Congressional moratorium passed late last year prevents states from levying Internet-related taxes until at least November 2003. Instead, the threat comes from across the pond, where the European Parliament is gearing up to vote this month on a proposal to tax digital goods sold and delivered over the Internet. The proposal would require non-European vendors to collect value-added tax, or VAT, on purchases by European customers of “virtual goods” such as software, videos, music, photos and educational products. Most of these vendors are U.S.-based. Yet curiously, in contrast to the storm of protest they raised just a few months ago over state taxation of the Internet, online retailers have shown almost zero concern over the likelihood that they will soon be subject to much higher European taxes. “We often have a hard time getting the American business community to focus on the fact that there are governments outside the United States that can royally screw up their business,” said Harris Miller, president of the Information Technology Association of America, a Washington, D.C., trade group. According to Miller, companies do have real cause for concern. Currently, most of the e-commerce in digital goods is between businesses, who can get reimbursed for VAT. But, Miller said, demand from consumers is expected to increase as more products become available online and more efficient connections permit faster downloads. “The European Union has the power to create a very unlevel playing field,” he said. 25 PERCENT TAX In the United States, the highest state sales taxes hover around 8 percent, and several states charge no sales tax at all. VAT rates, on the other hand, range from Luxenbourg’s 15 percent to a whopping 25 percent in some of the Scandinavian countries. Presently, European companies must charge VAT on sales of digital goods based on the country in which they are located. They have long complained that the current arrangement puts them at a disadvantage with respect to their competitors outside the EU whose sales are exempt from the tax. But the EU plan, which has been on the drawing board for a couple of years, had been held up by Britain over concerns about how it will be administered. Britain, however, backed down last month in exchange for a promise to replace the plan in three years with a less burdensome system. The latest proposal, which was agreed to in a meeting of EU finance ministers last month, requires non-EU companies to collect VAT according to the purchaser’s country of residence. To ease administration, companies would have to register in only one EU country instead of all 15. That country’s tax authority would then collect the VAT and transfer it to the treasury of the customer’s country. The plan is scheduled to be heard by the European Parliament in February. If the plan is accepted, member countries would then be given about 18 months to incorporate the directive into their national law. CAUSE FOR ALARM Industry trade groups say the proposal is rife with red flags for online retailers. They point principally to the requirement that companies verify the customer’s location to compute the VAT they are supposed to charge. This obligation puts non-EU companies at a serious competitive disadvantage, said ITAA’s Miller, because it will slow down the processing of Internet transactions. He gave the example of a small software gaming company with a largely youth-oriented customer base. “Can you really expect a teen-ager with the attention span of a gnat to sit through all kinds of questions about where he’s located? Forget it. He’ll just say ‘goodbye.’ “ The EU has not provided specifics as to how the verification process will work. Miller said this only adds to the problem. “Who knows what they’ll come up with?” he said. The verification process poses other problems as well, said Mark Nebergall, president of the Software Finance and Tax Executive Council, a Washington, D.C., trade group. “Companies could be exposed to liability from both sides,” he said, “from the government if the customer is undertaxed, and from the customer if he is overtaxed.” Industry advocates also expressed alarm over the prospect of proliferation. If the proposal goes through, it could pave the way for other countries to levy their own VATs on Internet transactions, Nebergall said. Such a result would compound the administrative problems already present in the EU plan, he said. Tax lawyers elsewhere said they were surprised by the seeming indifference of U.S. businesses toward the prospect of an EU online tax. “If this is actually going to a vote in February,” said Marvin Kirsner, a partner at Greenberg Traurig in Boca Raton, Fla., “things are far too quiet.”

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