Although the move to Madeira makes good business sense for any EU business which provides electronic services and doesn't need a 'bricks and mortar' establishment in a high-tax country, BT and Virgin give as their reason the competition they face from AOL, which under existing law is exempt from having to pay VAT in the UK because it is classified as a content provider, not a telecoms business.

"Should AOL seek to register for VAT in a comparatively favourable jurisdiction such as Madeira then clearly other UK ISPs would have to look at their own arrangements to see if such imbalance could be redressed by similar treatment," said Alison Ritchie, the chief executive of BTopenworld.

In a letter to Paul Boateng, the financial secretary to the Treasury, she demanded a "better explanation" of the VAT discrepancy, saying the rules give a significant competitive advantage to non-EU players. A BTopenworld spokesman said: "We don't want to see AOL enjoy exemption until July and then start operating from Madeira and charging lower rates than other ISPs."

Freeserve, the ISP owned by Wanadoo of France, is another company considering the move to Madeira, and joined BTopenworld two weeks ago in launching a judicial review of Customs & Excise's decision to allow AOL's exemption. John Pluthero, chief executive of Freeserve, has long campaigned for a level playing field and estimates that the exemption saves AOL about UK£40m a year - equivalent, he says, to a subsidy of £4.50 per customer per month on its high-speed broadband internet service.

Ms Ritchie told Mr Boateng: "Given typical broadband margins, this is a huge sum that could enable AOL to become the dominant retail provider of broadband access. "It is clearly perverse for the Government to prevent a genuinely competitive market at this important juncture, particularly when the advantage is being given to a US-based company," she said.