Freeserve is already planning to sue the UK government because it claims that AOL is being given an unfair advantage through a loophole in the UK tax laws, which saves the US company £30m a year.
AOL does not have to pay VAT because it is registered for tax purposes in the US and is classified in the UK as a site which provides content rather than telecoms services.
In a statement, Freeserve said, "No change in law is required in order to bring this outdated guideline into line with European law. Customs has repeatedly stated that it wishes to create a level playing field in this regard, but seems to see no urgency in removing AOL's £30m-a-year VAT advantage. This leaves us with no option but to bring the matter to the attention of the European Competition authorities."
Freeserve's lawyers are currently drafting letters to be sent to the competition authorities in Brussels by Friday, asking them to examine the UK's VAT laws regarding ISPs. It argues that the laws favour its US competitors and that AOL is mainly a telecoms service and therefore liable to tax.
The company says that customs minister Paul Boateng and e-minister Douglas Alexander have not answered their letters sent last week, which urged the government to revise the laws or face legal action.
In the letter to Boateng, Freeserve argues that "the government's failure to act puts it outside the scope of current Community law".
Freeserve has also threatened to move its business outside the EU unless the tax loophole is closed. The news that AOL is exempt from VAT was revealed earlier this year in a broker's report from Merrill Lynch.