Internet service provider Freeserve is to sue the UK government for protecting AOL from paying VAT.
At the centre of the dispute is a Customs and Excise 1997 ruling that exempts AOL from paying VAT because the company regards itself as a content provider and not a telecoms services company.
Freeserve has applied to the High Court for a judicial review of the exemption maintaining that the decision breached European law and that Customs and Excise and the Treasury had failed to take any action.
BTopenworld confirmed that, although it was not working with Freeserve, it had approached the Treasury on several occasions with similar concerns.
In 1999 a European Union directive ruled that all internet companies should pay VAT, and European governments were given a deadline of July 2002 to sort it out.
But Freeserve said that the government did nothing and is complaining that its inaction enables AOL to save £40m a year. This spare cash is important as competition in the market heats up in the battle for broadband customers.
Freeserve chief executive John Pluthero claimed that the UK government has been fobbing off Freeserve and BT for more than a year promising an imminent decision. "It's time for the evasion to stop and the litigating to begin," he explained.
A BTopenworld spokesman said: "Our feeling is that it would be better for the government to act on this sooner rather than later."
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