A question often posed by adsense publishers in the UK is: Should I pay VAT on my Adsense earnings? If you are located in the UK, then it's always best to contact your local HM Revenue & Customs office to double check. And preferable get an answer in writing. The answer that Adsense publishers have gotten from HMRC has varied, so it's better to be safe than sorry.
The general consensus amongst Adsense publishers (pre 2010) is that you do not need to pay VAT on your Adsense earnings. Google's European headquarters are located in the Republic of Ireland -- for European and UK publishers -- and are therefore out of scope for UK VAT.
Google Adsense earnings are classified as 'advertising commission'. Under UK VAT law, an advertisement service is supplied at the location of the customer. The customer in this case is Google. And they are still (early 2010) located outside of the UK. However, since January 2010, you may need to disclose a list of EU sales to HM Revenue & Customs: http://www.hmrc.gov.uk/vat/cross-border-changes-2010.htm.
Google did recently convert from reporting in $ to £ for UK adsense publishers, therefore, the chances for potential liability for VAT did increase, but currently the general advice is still that adsense is out of the scope for UK VAT. For future readers (article written in 2010), it's best to double check that no changes in the law or HMRC policy has recently occurred. Google and Facebook are often criticised in the UK media, and by UK politicians, for avoiding tax, so political pressure may force a change in HMRC's current policy.
Update (2011): Matts Cutts, a Google employee and popular blogger did publish a blog entry dealing with this exact issue -- located at http://www.matt-helps.com/google-adsense-and-vat/ -- and he stated after speaking with HMRC that UK publishers should handle adense earning in the following way: "All you have to do is put the amount of Adsense income for the period you're reporting (paper or online VAT form) into box 6 ...and that's it! ". It should be noted, however, that Matt is not an accountant, neither am I, and therefore you should always consult with HMRC and an accountant; as we can take no responsibility for the decision you make.