A taxing time

In the first two seconds of the interview, David Melville, freeserve’s company secretary and general counsel, blustered: “Did you know AOL Europe is not paying VAT in the UK?” This was more than a month ago, when Freeserve’s battle with UK Customs & Excise to resolve a tax issue relieving AOL Europe of UK VAT obligations was not public information. Only weeks later, on 15 November 2001, Freeserve revealed to the public that it was considering legal action against the UK Government over AOL Europe. Melville is at the head of this initiative and has had clearance from Freeserve’s main board to take the issue to the European Commission (EC).

Melville is keen to get the problem with AOL Europe off his chest. His main bugbear is that, although Freeserve pays VAT in the UK, rival internet service provider (ISP) AOL Europe doesn’t have to. Why? Because AOL Europe has cleverly taken advantage of a tax loophole in a way that Freeserve cannot.

ISPs can decide to charge users for either the content it broadcasts or the access to the telephone networks with which it provides them. All ISPs that charge for telephony pay VAT, but any ISP that charges for content, such as AOL, does not have to pay if that content is broadcast outside the EU. AOL Europe’s content comes from the US. Freeserve, whose content comes from within the EU, charges its customers for telephony and thus pays VAT; this is despite both ISPs offering the same broad service of unlimited internet access for a monthly subscription fee. Freeserve has threatened to move its business outside the EU if the tax loophole is not tied up.

“The Government has to decide: is somebody paying AOL Europe £14.99 a month for the content on AOL’s servers, or simply to use the internet? Some of the most popular reasons why people use the internet, such as to send email, have no relation to content and are pure telephony services,” Melville explains.

Melville recognises that AOL Europe has only been able to avoid VAT legally because UK Customs & Excise has allowed the loophole to exist. He insists his issue is with the UK Government for letting AOL Europe get away with it. But it is easy to suspect, in the crowded ISP playground, that Melville knows it is better to get a rival into trouble with an authority figure than to beat them up outside the school gates.

“We’ve had advisers who have refused to pitch for work, but there’s no room for being precious in this market”
David Melville, Freeserve

Whether history will remember Melville as someone who revolutionised e-commerce law or dismiss him as a jealous playground whinger is hard to predict right now. But it is unlikely that he will back down without a fight.

Melville has taken the issue firmly to heart. It was he who wrote to customs minister Paul Boateng saying that Freeserve could no longer tolerate the AOL Europe situation and may be forced to take legal action. And it is he who has spearheaded the move to the EC to force Customs & Excise to take action over AOL Europe.

But Melville is modest about his role in the battle. “If [Freeserve chief executive] John Pluthero had the time, he’d be camped outside Customs & Excise. This is an issue that Pluthero would lead in person if he could,” he says.
Melville has not yet chosen the external legal advisers he will use to take the battle to the EC. He has been using Olswang, one of his main advisers, to brief him on his claim to Customs & Excise, but remains undecided about whether to take advice from any UK firm on this issue.

Melville says he may look to French firms, or French branches of City firms, because Freeserve was taken over last December by French company Wanadoo, owned by France Telecom. Norton Rose and Gide Loyrette Nouel worked on the takeover for Wanadoo and France Telecom, but Melville is not sure whether he will be using either of them.
Melville also believes that French firms are good value for money. “I’d like to use someone in France, as generally legal fees in France are about a third of what UK City firms charge,” he says.

In common with many in-house lawyers working for e-commerce companies, value for money is permanently on Melville’s mind. Freeserve was valued at £10bn at the height of the internet boom, despite that fact that it was only formed in 1998. But at the time of its sale to Wanadoo in December last year, which took Freeserve out of the stock market, its value had dropped to £1.65bn.

“We’re more secure since the acquisition as we don’t have to worry about the vagaries of the capital markets,” says Mellville. “We’ve saved money on legal fees as we’re no longer a listed company. But like all businesses in this sector, we’re looking to keep our legal spend down to an absolute minimum.”

But instead of feeling low about his small legal budget, Melville uses it to his advantage. He does not have the financial option of keeping large amounts of lawyers on a panel, so he makes each law firm he uses prove to him time and time again that it is worth employing.

In addition to Olswang, Melvilles main advisers are Denton Wilde Sapte and Herbert Smith. He uses Olswang for technology work and litigation, Dentons for litigation and Herbert Smith for corporate finance. But although these three firms are Melville’s main advisers at the moment, he maintains no formal commitment to them.

“We’ve no formal panel,” he says. “If we need advisers they have to pitch for the work. We’ve had advisers who have refused to pitch for work, but there’s no room for being precious in this market.”

Melville also refuses to use any firm that is inflexible over its fees. One reason that Melville sticks to Dentons, Olswang and Herbert Smith is that they have all agreed not to push up their rates. Melville says: “Since about 1999, the general expense of our legal services hasn’t grown. We have a relationship with our external lawyers. They know that raising their fees would be unacceptable in this climate.”
David Melville
Head of legal

Organisation Freeserve
Sector E-Commerce
Employees 300
Legal capability Two lawyers
Company secretary and general counsel David Melville
Reporting to Chief executive John Pluthero
Main law firms Denton Wilde Sapte, Herbert Smith and Olswang