Freeserve said yesterday it may pull out of the UK because it claims that its largest competitor, AOL, has an unfair advantage over UK-based ISPs because the American firm does not have to charge its customers VAT on its flat-rate unmetered internet package.

America Online in the UK, says Freeserve, is an ISP, and therefore mainly supplies telecom services, making it liable to VAT.

Freeserve has written to Customs & Excise and the Chancellor of the Exchequer, Gordon Brown, to request that the UK division of AOL either be held responsible for VAT charges, or that the law itself be amended so that it is equally applied.

ISPs here must include the 17.5 percent VAT charge in their fees, which for Freeserve brings the total monthly fee for its flat-rate internet access package to £12.99, Freeserve said. If AOL was to add VAT to its current monthly flat-rate internet plan of £14.99, it would have to charge its customers £17.60 per month, Freeserve added.

For its part, AOL said in a statement that it complies with the UK tax laws. The company's status as a provider of information services from outside of the EU is "a status available to any other similarly positioned service provider", AOL said.

According to Freeserve, owned by Wanadoo, the ISP subsidiary of France Telecom, the UK is the only country in Europe where AOL is free from VAT charges. A representative at AOL UK said he was unable to comment on AOL's tax commitment elsewhere in Europe, but added that the issue did not appear to be germane to Freeserve's complaint to Customs & Excise.

Representatives at the Treasury could not immediately be reached for comment.

The loophole is a result of a 1997 Customs & Excise guideline, issued by the Treasury, that exempted ISPs not based in the EU from UK VAT liability as long as the ISP mostly produces content instead of telecommunication services, Freeserve said in a statement.