LONDON (Reuters) - Car service Uber is using a gap in EU and UK tax rules to avoid incurring sales tax on the booking fees it charges drivers in Britain, a practise a senior politician said was unfair to competitors and defied the intent of the law.

San Francisco-based Uber charges lower fares than rival ride hailing apps. In Britain, its competitors’ fares include 20 percent value added tax (VAT) on booking fees, but Uber’s fares do not.

Uber is able to avoid VAT by exploiting a loophole in how the tax is collected for business-to-business sales across EU borders, which arises because it treats its 40,000 UK drivers as separate businesses, each too small to register for VAT.

It confirmed to Reuters that it does not pay value added tax on the fees it charges British drivers. By contrast, two of its main UK rivals, Gett and mytaxi, both said they do pay VAT on their fees. They declined to comment on Uber’s practise.

The loophole applies in other European countries too, but is particularly important for Uber in Britain which accounts for a third of its European business. Other EU countries have put tighter rules in place to close or narrow the loophole.

Paying VAT on Uber’s fees would cost the company about 1,000 pounds a year on average for each of its UK drivers, based on information Uber has given about the size of its British business, which is growing rapidly under its expansion plans.

Uber told Reuters it respected the tax rules in all the countries where it operated. Asked whether avoiding paying value added tax gave the company an unfair advantage over its rivals, a spokesman said: “The same rules apply to any international service provider with customers in the UK.”

Her Majesty’s Revenue and Customs (HMRC), the UK tax authority, declined to comment on Uber, citing confidentiality rules. A spokesman said: “Everyone has to pay the tax due under the law and we make sure they do.”

Three European tax experts consulted by Reuters said Uber’s practise probably complies with the way Britain has decided to implement EU rules.

But Margaret Hodge, a member of Britain’s Labour Party who has long led parliamentary investigations into corporate tax avoidance, criticised Uber’s practise of not paying VAT on its fees, when told of it by Reuters.

“It is yet another example of how large companies find loopholes and use the law for a purpose for which it was never intended,” she said. “There is a failure to pay tax that should be due. That reduces the money available for public services and is unfair on Uber’s competitors.”

The same loophole is used by other companies such as Google and Facebook to avoid VAT on certain transactions involving small businesses, but the benefit is more important for Uber, since the fees it charges drivers are its main source of income.

Even as Uber has become a transportation powerhouse around the world, opponents, including established taxi operators, have mounted legal and public relations attacks on the Silicon Valley company, saying it owes its success to bending the rules.

FILE PHOTO - A man arrives at the Uber offices in Queens, New York, U.S. on February 2, 2017. REUTERS/Brendan McDermid/File Photo

Several high level executives have left Uber in recent months, and its CEO was forced to apologise after being filmed haranguing one of its drivers. It has hired former U.S. Attorney General Eric Holder to investigate its corporate culture, including accusations of sexual harassment.

In Europe, the lead advocate to the European Court of Justice concluded in May that Uber is a transportation service, not an information platform, and therefore open to far greater regulation.

In the United States it also faces a Justice Department criminal investigation into software used to prevent law enforcement officials from hailing Uber cars, to shield the company from regulators.

Despite those troubles, Uber has been growing rapidly, rolling out its service in new cities month by month.

REVERSE CHARGE

Uber avoids having to charge British value added tax on its booking fees by treating each driver as an individual business and then billing drivers across EU borders from its Dutch subsidiary, using an EU VAT provision called the “reverse charge”.

The rule lets businesses sell goods or services to other businesses across EU borders without paying VAT. There is usually no loss of tax revenue, because the importing business collects VAT from its own customers.

But since Uber drivers mostly generate less than the 85,000 pounds a year sales threshold to register for VAT in Britain, they don’t have to collect it.

Gett and mytaxi both bill their drivers from companies within Britain. As the reverse charge does not apply to domestic sales, that means that unlike Uber they must charge drivers VAT.

Uber is not the only big American firm to use EU reverse charge rules to reduce the VAT tab when billing small business clients across EU borders. Google and Facebook use the same approach when selling from their Irish regional headquarters.

That means British plumbers or guesthouse owners who are not registered for VAT can buy advertisements from Google or Facebook without being charged the tax, even though they would pay it when placing an advertisement in a local newspaper.

"It is a system failure because the rules are not harmonised in respect of dealing with small businesses," said Pascal Schrijver, a partner with Deloitte in Amsterdam. Google GOOGL.O said it followed all tax rules. Facebook FB.O declined comment.

The EU’s reverse charge regime was intended to cut paperwork required to distribute VAT revenue among EU countries by placing the responsibility for collecting it on the importing country. It was not intended to allow companies to escape VAT altogether, said Laurent Lattmann, a VAT partner with advisory Taxand in Zurich.

“A supplier should not use the reverse charge if they are selling to a customer without a VAT registration,” Lattmann said.

Other EU countries often have lower sales thresholds to register for VAT, and several have systems in place to ensure that buyers that are not VAT-registered pay the missing tax when they import goods or services VAT-free across EU borders.

Germany has imposed a requirement on non-VAT registered businesses to complete a special form and pay the tax when they import reverse-charged goods or services, said Barbara Fleckenstein-Weiland, tax lawyer with Flick Gocke Schaumburg in Frankfurt. Erwin Boumans, Brussels-based tax partner at accountants BDO said Belgium had a similar system.

“The cultural attitude of tax authorities is very different from country to country. The UK has historically taken a light touch approach,” said Nicholas Hallam, Chief Executive of UK VAT advisory Accordance.

“TREADING WATER”

Uber is privately-held and does not publish accounts, but says it has more than 40,000 drivers in Britain who each bring in an average of around 560 pounds a week in gross fares. It normally charges fees of 20-25 percent of the fare.

That suggests the company is collecting more than 200 million pounds a year in fees on more than 1 billion in UK fares, and saving at least 40 million by not paying VAT. Uber declined to comment when presented with those calculations.

If Uber were forced to pay VAT on its fees and tried to pass the extra cost on to drivers, many would quit, said Jason Shepherd, a London Uber driver who moved with his wife and kids into his in-laws’ house to make ends meet.

“Most Uber drivers are just treading water,” he said. “If Uber put up its fees I would immediately consider other options and I’m sure most other drivers would too.”

James Farrar, an Uber driver trying to organise fellow drivers into a union, said typical drivers earn only around 6 pounds an hour after car rental, insurance and other costs.

“Even with surge fares, it’s less than the minimum wage” of 7.50 an hour, he said. Uber says drivers who rent their cars earn more than 8 pounds an hour on average.