The European Union (EU) is preparing to strike another blow against the still-recovering Internet economy.

A new regulation comes into effect July 1. It requires companies outside the EU to collect VAT on digital services. The rule will affect private individuals more than business customers.

It means higher prices for European consumers and more expense for companies outside the EU that do digital business in Europe.

European Council Directive 2002/38/ECM says that: "Digital delivery within the EU of software and computer services generally, plus information and cultural, artistic, sporting, scientific, educational, or entertainment services, specifically will be subject to VAT. When such services are supplied for consumption outside the EU, they are exempt from VAT."

Self-assessment Under the rules, no obligations will be imposed on non-EU suppliers selling to business customers in the Union (which constitute at least 90 per cent of the market, according to the EU): "Since the VAT will be paid by the importing company under self-assessment arrangements."

However, the rules require suppliers of digital products from outside the EU to charge VAT on sales to private consumers.

According to the EU, the directive covers the gamut of electronic services: "Web site supply; Web hosting; distance maintenance of programs and equipment; supply of software and updating of that software; supply of images, text and information and making databases available; supply of music, films and games, including games of chance and gambling games, and of political, cultural, artistic, sporting, scientific and entertainment broadcasts and events." Distance teaching is also affected.

VAT attack This means a consumer in the UK can expect to pay VAT on digital goods acquired from a company based outside the EU. It also means that the vendor will have to administrate the collection of such tax, and deliver the money collected to the EU.

The European Commission states that to deliver such services: "Non-EU suppliers will be required to register using special simplified arrangements with a VAT authority in any one Member State of their choice and to levy VAT at the rate applicable in the Member State where the customer is resident."

These rules will not be easy to police. The only major online services company to have announced plans to collect the tax is eBay, which announced its plans to do so on June 8.

Meanwhile, the US Direct Marketing Association (DMA) has been lobbying the EU to change the law, with no result.

DMA president and CEO Robert Wientzen said: "The EU is setting up a discriminatory price structure against non-EU companies. The Internet and e-commerce are borderless, they cannot be and should not be weighed down by geographic political controls. Such a broad taxing scheme will act only to limit the growth of e-commerce in the EU."

"It is extremely burdensome and costly for every non-EU Website operator to register and comply with the maze of regulation that the EU has established," said Charles Prescott, vice president international business development and government affairs at the DMA.