Online trading is big business. With monthly retail sales recently reaching the £1 billion mark and 45% of homes in the UK now online an increasing number of businesses are realising the benefits of e-commerce. Later this year global competition amongst suppliers is set to intensify further with the introduction of new EU-wide VAT legislation.

The proposals, which will take effect from 1 July 2003, will impact on businesses providing electronically supplied services, such as downloading games and music, distance learning and on-line training as well as all television and radio broadcasting services.

UK suppliers will no longer be required to charge UK VAT on the supply of electronic and broadcasting services to businesses within the EU or to non-EU customers. UK VAT however must still be charged to UK consumers and private individuals and non-business organisations resident in other Member States. Conversely a UK business receiving supplies of electronic and broadcasting services from a non-UK business will be required to account for UK VAT under the reverse charge procedure, ie VAT is collected from the UK taxable customer.

Currently, despite a few exceptions such as the telecommunications industry, normal VAT rules apply which means that services are charged in the EU country where the supplier is located. UK businesses are therefore required to charge VAT on the supply of electronic and broadcasting services irrespective of the customer's location. Suppliers based in countries outside the EU however, such as the United States, are not required to charge VAT giving them a significant competitive edge.

The main issue for businesses is likely to be how they verify the business status and location of the customer to decide whether they need to charge VAT. Unlike traditional manufactured goods which have to cross borders physically and can be easily identified, digitised products can be bought and sold without any obvious indications of a transaction having taken place. And as technology enables customers to obtain access to and use on-line services whilst travelling between different destinations verification can be extremely difficult.

It will obviously be easier to verify the status and location if the customer is based in the EU and has a trading history because such businesses are required to keep books and records. In such cases the customer's VAT number and country code will normally be sufficient evidence. But where there is no prior business relationship HM Customs and Excise (HMCE) recommend that the VAT number be checked where the tax exceeds £500 on a single transaction or the cumulative amount on services supplied to a single customer in a VAT quarter exceeds £500. It would be advisable for businesses to start thinking now about how they can adapt their software to facilitate these changes thereby avoiding unnecessary "red-tape" from 1 July.

It goes without saying that the changes will have the greatest impact on non-EU businesses which, without specific measures, would normally be required to register and account for VAT in every EU Member State where they make supplies. However, HMCE has tried to alleviate the additional burden on such businesses by implementing a special scheme which will enable businesses to register electronically in a single Member State of their choice and declare the EU VAT due on a single electronic VAT return. The Member State of registration will then distribute the VAT to the appropriate Member State.

The changes are to be welcomed but they do not represent the final position and we can expect to see a fully electronic solution which will automatically charge, collect and allocate the tax with effect from 1 July 2006.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.