PayPal, the online payment service owned by eBay Inc, is backtracking on its policy against processing sales of e-books containing themes of rape, bestiality or incest after protests from authors and anti-censorship activist groups.

PayPal's new policy will focus only on e-books that contain potentially illegal images, not e-books that are limited to just text, spokesman Anuj Nayar said on Tuesday. The service will still refuse, however, to process payments for text-only e-books containing child pornography themes.

The revised policy will also focus on individual books, rather than entire classes of books, he added. E-book sellers will be notified if specific books violate PayPal's policy, and the company is working on a process through which authors and distributors can challenge such notifications, the spokesman said.

This is going to be a major victory for writers, readers and free speech, said Mark Coker, founder of e-book distributor Smashwords. They are going to build a protective moat around legal fiction.

PayPal warned Smashwords and some other e-book publishers and distributors earlier this year that it would limit their PayPal accounts unless they removed e-books containing themes of rape, incest, bestiality and underage subjects.

PayPal's original policy was criticized by groups, including the Authors Guild and the National Coalition Against Censorship, which voiced concern that banks and payment companies may be exerting too much control over what books can be written, published and read.

PayPal is relaxing the policy after the main credit card companies made a distinction between extreme pornographic images and e-books that explore such topics with only the written word.

PayPal told e-book distributors earlier this year that the original policy was in place partly because the banks and credit card companies it works with restrict such content.

However, Doug Michelman, global head of corporate relations for Visa Inc, suggested that the company would not crack down on e-books that explore such topics, according to a letter he wrote that was posted on the blog Banned Writers. A Visa spokesperson confirmed that the letter was real.

The sale of a limited category of extreme imagery depicting rape, bestiality and child pornography is or is very likely to be unlawful in many places and would be prohibited on the Visa system whether or not the images have formally been held to be illegal in any particular country, Michelman wrote. Visa would take no action regarding lawful material that seeks to explore erotica in a fictional or educational manner.

A MasterCard spokesman drew a similar distinction on Tuesday, saying that the company would not take action regarding the use of its cards and systems for the sale of lawful materials that seek to explore erotica content of this nature.

PayPal's new policy will still prohibit the use of its service for sale of e-books that contain child pornography, or e-books with text and obscene images of rape, bestiality or incest, the spokesman said.

PayPal has not shut down the accounts of any e-books publishers involved in this debate, he added.

PayPal's continued limit on child pornography is consistent with Smashwords' existing policies and those of the retailers it works with, Coker said. He met with top PayPal legal representatives on Monday.

Child exploitation is at the center of their concerns -- no erotic content for fiction involving underage people, Coker said.

However, Joan Bertin, executive director of the National Coalition Against Censorship, was still concerned about PayPal's approach.

Verbal descriptions of child pornography are not illegal. That's why we can read Lolita. she said. Actual images of child pornography are a different situation all together -- if they are photos of actual children.

I'm glad they're moving in the right direction, but I hope they continue to consider potential problems they are creating for themselves and their customers by getting involved in such policing, Bertin added. I don't think we need another quasi police force trolling the Internet.

(Reporting By Alistair Barr; Editing by Steve Orlofsky, Bernard Orr)

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