The loophole allows retailers to sell goods such as CDs, DVDs, computer games and contact lenses that are valued at under GBP18 VAT-free from Jersey and Guernsey back to the UK through websites. The Channel Islands are not part of the EU for VAT purposes and, therefore, goods under this value sent by mail order from the Islands are exempted from VAT.

However, according to the FPB's report, presented this week to the Treasury at the request of the Paymaster General Dawn Primarolo, the actions of these firms are having a crippling effect on the sales of independent UK-based high street shops.

The FPB’s Chief Executive, Nick Goulding commented that the dossier is "compelling evidence" of the profound damage being done to small businesses and the music industry.

“Our message to the Treasury is clear,” he stated.

“Small businesses must be able to compete on a level playing field. It is totally unacceptable, unfair and anti-competitive that a business like Tesco which has a turnover of £34 billion should gain a competitive advantage over tax-paying small businesses by avoiding tax," he observed.

Government Minister John Healey told a Treasury sub-committee meeting in February 2005 that the Treasury is losing £80 million a year in revenue as a result of large retailers exploiting the VAT loophole. He estimated that the revenue loss is expected to rise to £200 million over the next two years.

The FPB is calling on the Treasury to lower the price level on goods which VAT is exempt from 22 euros to 10 euros - equal to about GBP7 - thus rendering the trade unprofitable.

The Forum also wants the Treasury to seek a special dispensation from the European Union to close the loophole altogether. While this could be a protracted legal process, the FPB has pointed out that a similar dispensation has been granted to the Danish Government.