In July, Freeserve, now owned by France's Wanadoo, threatened to quit the UK because it claimed that its rival America Online is gaining an unfair advantage by exploiting a loophole in UK tax laws.
AOL, which is one of the UK's most popular ISPs, does not pay VAT because it is registered for tax purposes in the US.
In the latest turn of events, Freeserve has, according to a report in The Times, written to Paul Boateng, the customs minister, warning him that it will take legal action if the tax situation is allowed to drag on much longer.
Freeserve argues that under the current rules AOL is saving around £30m, which would otherwise go to the Treasury. The news that AOL does not charge VAT was revealed in a broker's report earlier this year from investment bank Merrill Lynch. According to the report, for every 100,000 flat-rate customers, AOL earns £2.6m a year by not charging VAT.
The US company has avoided VAT because of a 1997 Customs & Excise ruling, which states that non-UK ISPs classified as supplying content, rather than telecoms services, are exempt from VAT.
In the summer, Freeserve chief executive John Pluthero said his company would have to consider moving out of the UK unless Customs & Excise changes AOL's tax position to create a "level playing field".
Freeserve claims that AOL is mainly supplying a telecoms service and is, therefore, liable to VAT. Freeserve has called on chancellor Gordon Brown and Customs & Excise to change AOL's status.
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