The World Trade Organisation let the EU impose the sanctions after it ruled the tax breaks, called the Foreign Sales Corporation (FSC), illegal. The US Senate Finance Committee on Wednesday passed a bill aimed at meeting the EU demands.

But Arancha Gonzalez, spokeswoman for EU Trade Commissioner Pascal Lamy, said the proposed law still had holes in it as it included a three-year transition period to end the FSC system.

"We have already waited for three years to get the legislation repealed and therefore an extra three year period could not be acceptable to us," she told a news conference.

The EU was encouraged that the process to repeal the disputed law was moving ahead in Congress, but she added: "We would impose sanctions if and when the illegal FSC is not replaced by the end of the year."

The launch of the sanctions, the biggest awarded by the WTO, would hurt US exporters and damage trans-Atlantic trade ties, already strained by other disputes and seeking new direction after the collapse of world trade talks in Cancun last month.

Lamy has given Washington until autumn to change its tax laws or he will launch the EU internal legislative process that would result in the sanctions, in the form of punitive duties on a wide range of US goods, from January 1.

President George W Bush proposed repealing the FSC system, which grants tax breaks for giants such as Boeing and Microsoft, in his budget for 2004.

But Congress has come under pressure from industry not to hastily scrap the scheme. Boeing said last year such a move could put 10,000 jobs at risk.

The bill approved by the Senate Finance Committee would use the $50 billion generated by repealing the FSC tax breaks to cut taxes for manufacturing in the hope of savings jobs at a time when companies have been shedding millions of employees.

The bill would lower the corporate tax rate for manufacturers from 35 per cent to 32 per cent.

But according to documents in the Senate Finance Committee's Web site, the bill also provides for a three-year transition period, keeping up to 80 per cent of the benefits of the scheme.