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First blood to Freeserve in its battle to force rival internet service provider to pay VAT on its UK service.

Internet service provider Freeserve has won the first round of its high court battle to force rival AOL to pay UK VAT charges.

In London’s High Court, Mr Justice Moses ruled Freeserve’s challenge of Customs & Excise’s decision in March not to charge AOL VAT on its internet packages was ‘arguable’. The case will now go ahead to a full judicial review hearing, at a date to be set.

The row between UK’s leading ISPs over AOL’s current VAT-free status in Britain for its internet services has been rumbling on for more than 18 months. Freeserve argued last July that by not paying VAT, AOL had an unfair advantage over UK-based ISPs, and called it a ‘distortion of competition’.

Following legal advice, Freeserve argued AOL should no longer use a Customs guideline to avoid paying VAT on its UK ISP service. The 1997 guideline exempts non-European ISPs from UK VAT, providing its supplies are classed as mainly content, not telecommunications.

Freeserve claimed US-based AOL can no longer classify itself as mainly a content provider. It cited AOL’s own marketing, pointing out that its website says it is mainly a telecommunications service.

Freeserve had also claimed a more recent European law forbade companies from circumnavigating VAT laws by artificially splitting a service. But Customs commissioners in March said they ‘could not be certain’ AOL fell into that category and ruled in its favour.

In retaliation, Freeserve upped sticks and moved its flagship Anytime service to Madeira, where VAT is charged at only 13.5%. It subsequently said this was a ‘permanent’ move.

In court, Freeserve’s counsel, David Pannick QC resurrected this argument and said AOL should be charged VAT if its business in the UK ‘predominantly’ consisted of ‘telecommunication services’. Although an expected change to European law, due to take place in July 2003, would rescind AOL’s VAT-free status, Mr Pannick said AOL would still have escaped paying an estimated #100m in VAT on its internet packages between June 2001 and July 2003.

Roderick Cordara QC for AOL, described Freeserve as a ‘disgruntled competitor’ who had no business ‘prying’ into the US giant’s confidential dealings with Customs.

Nevertheless, Mr Justice Moses said it was possible the commissioners had placed an erroneous reliance on the projected change in the law, which would make AOL ‘unequivocally’ subject to VAT. He also said Freeserve could argue that the commissioners had applied ‘too stringent a test’ when deciding whether AOL’s UK business was predominantly telecommunications based.

AOL was contacted, but said no-one was available to comment at time of going to press.

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