European finance ministers have agreed on a system for collecting value-added tax (VAT) on online sales of digital products, including software, and services such as internet pay-TV.

Under the system, companies based outside the European Union will have to pay the VAT rate in the country where their customers are, through one portal country of their choosing. That country would then pass on the VAT to the consumer's country.

The system covers only business-to-consumer (B-to-C) transactions. Around 90 per cent of e-commerce sales are business-to-business transactions, which are covered by separate rules. At present, most US firms don't add VAT on B-to-C transactions with EU consumers.

Different rates Firms within the EU that sell digital products or services over the internet will continue to pay VAT at the local rates in their country, although some countries, including the UK, have not charged VAT in the absence of any EU ruling until now.

Under the new laws, EU companies selling to end consumers outside of the EU will be able to do so VAT free. This will "remove a major competitive handicap" on European firms competing on the world market, said Frits Bolkestein, commissioner in charge of the internal market at the European Commission.

Under the regime, a US software company will have to add 25 per cent onto the sales price of its software if the consumer is in Sweden. A rival company based in Luxembourg will have to add only 15 per cent to the price for the same customer in Sweden.

US Deputy Treasury Secretary Kenneth Dam said the Bush administration will try to convince the EU during talks at the Organization for Economic Cooperation and Development that the rules are unworkable. The OECD is trying to find a global consensus on taxing e-commerce. If that fails, Washington may lodge a complaint at the World Trade Organization, Dam said last Friday.