Though the discussions came close to an agreement, objections from Germany, Luxembourg and Portugal mean that only an interim arrangement can be put in place. The talks were brokered by Austrian finance minister Karl-Heinz Grasser because Austria currently holds the EU Presidency.
VAT is currently charged at the rate of the seller's country. In order for e-commerce to be more effective, argued the EU, it should be charged at the rates of the buyer's country. That situation has led to e-commerce firms shopping around for the lowest VAT rate nations and establishing their businesses there.
Luxembourg and Portuguese Madeira have the lowest VAT rates in the EU and have seen scores of e-commerce firms flock to set up business there. They were two of the objecting nations to the proposal.
"We failed to reach a consensus for the VAT package but we did get broad support for our package," said Grasser.
Other European nations are reportedly unhappy at losing tax revenues to Madeira and Luxembourg, with consumer in other countries paying only the rates set in Madeira and Luxembourg. The lowest permissible rate in the EU is Luxembourg's 15%, but Madeira, which is a Portuguese island, has special dispensation for a 13% rate. In contrast, Sweden and Denmark have a VAT rate of 25%.
Luxembourg hosts the European headquarters of some of internet trading's biggest names, including Apple's iTunes, Amazon.com, AOL, Cisco Systems, eBay/Skype and Microsoft.
Europe's finance ministers met in Luxembourg to discuss the change but could not reach unanimous agreement. Because all tax harmonisation plans must be unanimously agreed, the plan failed.
Germany's opposition is on different grounds: it does not want to change the VAT regime ahead of a planned rise from 16% to 19% in its own VAT rates. Germany and Portugal have agreed to have a discussion on how to resolve the dispute, said Grasser.
What about the Channel Islands?
There is no VAT in the Channel Islands (Alderney, Guernsey, Jersey, Hem and Sark), which do not form part of the EU. However, goods shipped from there to EU countries may be liable for VAT. An EU law provides for VAT relief on the shipping of items with a value of £18 or less, which is why Guernsey and Jersey – the largest islands – are a popular base for companies selling DVDs and CDs.