The EU will soon have the authority to impose against the US the heaviest trade sanctions in the history of the World Trade Organisation, following a WTO ruling yesterday that a US tax break for big exporters violates global trade rules.

The WTO's appellate body found the US corporate tax scheme was a hidden and illegal export subsidy, exhausting the final avenue of appeal open to President George W. Bush's administration. The ruling could poison EU-US relations at a moment when Washington is threatening to curb imports of steel from Europe and other countries.

Although both sides have tried to keep the tax dispute from damaging their trade relations or derailing the new global trade round, failure to resolve it quickly could lead to escalating conflict.

The ruling opens the way for EU trade sanctions on US exports by April, unless Washington ends the subsidy. The tax break is worth about $4 billion (€4.5 billion) annually to US firms such as Boeing, Microsoft, Caterpillar and Kodak. The dispute involves a 31-year-old provision of US tax law that US firms say is needed to level the playing field with European competitors, which do not pay taxes on income earned abroad. The scheme, which allows US corporations to exclude from taxation certain types of income earned outside the US, is most commonly known as the foreign sales corporation (FSC) provision.

The EU, which has fought the case in the WTO since 1998, has won its claim that the provision unfairly benefits US companies, which under US law would otherwise be taxed on all income earned worldwide.

"We have made a point of handling this dispute in a very reasonable manner," said Mr Pascal Lamy, EU trade commissioner. "Now it is up to the US to comply with the WTO's findings to settle this matter once and for all. As to how, we look forward to rapid US proposals."

The US, however, gave no indication yesterday that it was prepared to change the tax scheme in any fundamental way. Mr Robert Zoellick, US trade representative, said the US intends "to continue to seek to co-operate with the EU in order to manage and resolve this dispute".

Mr Peter Davidson, Mr Zoellick's chief legal adviser, will visit Brussels this week for discussions on resolving the dispute. However, it is unclear whether the US will make any concrete proposals.

The EU holds most of the cards. Thanks to yesterday's ruling, it will be free to retaliate against the US and will start drafting a sanctions list by April.