Consumers will no longer be able to take advantage of a tax loophole that allows digital goods to be bought from non-EU sites free of VAT.
European finance ministers yesterday agreed a regime for collecting VAT on online sales of digital products such as computer software and digital downloads.
Under the new system companies based outside the EU will now charge VAT at the rate of the country where the customer is based.
Under the current system a consumer living in the EU would not have to pay VAT on goods purchased outside the EU, which may encourage people to buy goods from abroad, forcing an unfair disadvantage on EU companies.
The new rule will "remove a major competitive handicap" on European firms competing in the world market, said Frits Bolkenstein, commissioner in charge of the internal market at the European Commission.
But some are arguing that the new regime has now tipped the scales too far in Europe's favour.
The USA is currently trying to convince the OECD (Organisation for Economic Cooperation and Development) that the rules are unworkable.
The OECD is trying to find a global concensus on taxing e-commerce. If it fails, US Treasury Secretary Kenneth Dam, may lodge a complaint with the World Trade Organisation.
A US software vendor will have to add 25 percent onto the sale price of its software if the purchaser is in Sweden, thereby paying VAT at the buyer's local rate. Whereas, a rival company based in Luxembourg will only have to charge VAT at 15 percent (its local rate and the lowest in the EU) on the same transaction.
The rules for companies within the EU will not change. The UK currently taxes all digital downloads as a 'supply of service', charged at 17.5 percent.
The regime only covers business-to-consumer transactions, as business-to-business sales are dealt with under separate rules.
"For too long EU companies have been disadvantaged and this is really a way of levelling the playing field," said Lisa Billard, Customs and Excise spokesperson.
The new rules will come into effect across the EU by 2003.