Some ISPs may be forced to increase prices for broadband services because they are now liable for VAT under a new European Union (EU) directive.
The first ISP to announce an increase is fairADSL, which was previously exempt from paying VAT to the UK government because it could claim that its services were based in the US.
FairADSL said today that, because of the EU directive, it now has to pay full UK VAT at 17.5 per cent and will have to pass this on to customers.
The directive, which came into effect on 1 July, requires all suppliers of digital services from outside the EU to pay VAT on sales inside EU member states.
But fairADSL, which is now based in the UK, is not the only ISP that was able to benefit from VAT exemption.
AOL has also been exempt until now because of an agreement with Customs and Excise.
This allowed AOL to be treated as a supplier of digital content rather than an ISP delivering internet access, which would have brought it within UK VAT rules.
Freeserve challenged the legality of AOL's agreement with Customs and Excise based on European case law and began lobbying the European Commission and the UK Treasury some 18 months ago.
It wanted to remove the discrepancy, which it claimed was distorting competition in the UK.
But AOL will not have to pay UK VAT as it has set up a new business unit in Luxembourg, which has one of the lowest rates of VAT in Europe at 15 per cent.
A spokesman for AOL said that the company had no plans to pass on the price rise to customers as it planned to absorb the extra costs.
Patrick O'Neill, fairADSL's communications director, explained that the increase will amount to around £1 per month, and will only affect new customers from the end of August.
Existing customers can continue to receive broadband for £18.99 a month if they renew their contracts for another year before 30 July.
"We were one of the few ISPs which passed the benefit on to our customers [of not paying VAT] and there are some which have registered their business units in places such as Madeira or Luxembourg as the rate of tax is lower," said O'Neill.
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