VAT is to be levied on e-services from non-EU firms, writes Jamie Smyth, Technology Reporter

Irish consumers may see the cost of digital products, such as software or music bought online, rise by up to 21 per cent from next week, as non-EU firms begin to collect VAT for the first time.

US-based firms, such as AOL, eBay and a host of software firms, will from Tuesday have to comply with a new EU directive, which introduces a system of taxation for electronic services.

The rules apply only to downloaded digital content supplied by non-EU suppliers to private consumers based in the EU and electronic services provided by firms such as eBay. For tangible goods, such as books, which are delivered by post, the existing tax regulations will remain in place.

The 2002 directive, which was transposed into Irish law in this year's Finance Act, will force all non-EU firms to levy VAT from consumers and pass it on to governments. Firms based in the EU have always had to charge VAT on such sales.

The decision to charge VAT should boost Exchequer coffers but may hurt the competitiveness of non-EU firms in Europe.

The EU's decision to charge tax reflects the growing importance of digital sales, according to Mr Seamus Mulconry, an e-commerce expert at Accenture. "I think governments expect digital purchases to become more important and frequent, especially for things like music and software. . . Look at what Apple is doing."

Apple has sold five million digital songs from its iTunes music store in the eight weeks since it was set up in the US. The company plans to introduce the new service in Europe when various music rights issues are resolved.

Currently US-based firms such as AOL, which has six million European subscribers, have avoided collecting VAT for their internet service provider service. This has given AOL, and other US firms, a competitive advantage over European-based firms that have collected the tax, he says.

The US government last year set a two-year moratorium on introducing taxes for digital and electronic services following lobbying by firms. But Europe's traditional dependence on VAT, compared to the US, was a factor in the EU's decision, he says.

From Tuesday, European Union consumers will have to pay VAT at the rate applicable in their own state - 21 per cent in the Republic - or at the VAT rate of an EU state where the supplier company sets up a hub. In most cases, compliant firms will collect the tax and pass it on to the member-state's governments.

The Revenue Commissioners will shortly begin registering electronic suppliers of digital goods and services for VAT. An information leaflet on the new regime is being prepared and will be available on its website (www.revenue.ie) shortly.

However, a Revenue Commissioners spokesman says it is impossible to estimate how much revenue will be generated from the new regime. No government system is in place to measure the amount of VAT collected from internet purchases but, with business-to-consumer e-commerce transactions predicted by consultancy IDC to be worth $235 billion (€200 billion) by 2006, it is likely to be a significant figure.

Mr John Fay, a partner in PricewaterhouseCoopers, says the system will lead to some anomalies in terms of the VAT rates applying to certain items which are sold in the Republic.

"For example, customers who buy books in physical format do not pay any VAT, as books in most instances are zero rates," he says. "But if the customer buys the book in digitised format over the internet from a US provider, VAT at 21 per cent will apply."

Compliance will also be an issue, with many digital content providers, such as those selling online pornography, likely to try to avoid collecting the VAT tax.

Beyond the implications for consumers, the EU directive could also have serious consequences for the Republic's allure as a location for certain types of foreign investment, says Mr Fay.

"From an 'Ireland Inc' perspective, while logically one would expect more tax to flow into the Exchequer, there may be some important messages in the context of foreign direct investment and the negative impact the relatively high standard VAT rate may have," he says.

The Republic's 21 per cent rate of VAT is significantly higher than the equivalent rates in most other EU countries - Luxembourg (15 per cent); Germany (16 per cent); Spain (16 per cent); Portugal (17 per cent); UK (17.5 per cent); Netherlands (19 per cent); and France (19.6 per cent).

The new VAT directive enables a non-EU company to set up a hub in a single state and collect a single rate from all EU citizens, at the level applicable in the jurisdiction where it is based. Ireland's higher VAT rate may act as a disincentive to attracting mobile e-business ventures from non-EU countries, says Mr Fay.

Mr Joe Macri, general manager at Microsoft Ireland, one of the Republic's biggest employers, is concerned about the directive's impact on the Republic. "Having a VAT rate of 21 per cent makes it difficult to attract new investment to Ireland, though it won't affect our current investments."

Microsoft plans to distribute its software to European consumers from its European Operations Centre in Dublin. By centralising at a hub in a lower VAT jurisdiction, Microsoft could potentially make its software cheaper for consumers. Mr Macri says the firm would prefer the VAT rate to be lower but other factors also play a part in deciding were to locate such as corporation tax rates, workforce skills and infrastructure.

Certainly, non-EU companies are responding to the directive in different ways. AOL, which employs about 1,000 staff at support operations in Waterford, has decided to centralise all its source of supply for European customers to a single location, Luxembourg, according to AOL spokeswoman, Ms Mia Kulla.

"If we had not done so, we would have had to comply with 15 different VAT reporting and payment regimes," she says.

EBay will levy the VAT rate applicable on its "sellers" country of origin. The VAT will be levied on the services fees that eBay charges people who use its site to auction products.

"We will pass on the VAT just as they do in the offline world," says Ms Jennie Reed, marketing communications manager at eBay UK. "We have a different site for each EU country so it is very simple to collect the tax."