The European Union has begun laying the groundwork for a legal challenge to a proposed US border tax, in what could be the biggest case in World Trade Organisation (WTO) history.

The move comes as President Donald Trump mulls over the backing of a shake up to the US corporate tax system that would see the inclusion of a new “border adjustment” system – whereby imports to the US would be subject to taxes, but not exports from the country. It is unclear if the proposal, which is being pushed by Paul Ryan, the speaker of the house of representatives, and Kevin Brady, chairman of the house’s tax-writing ways and means committee, is the same as the high tax on goods from Mexico or China that has been touted by Trump.

The proposal does not comply with international trade rules according to senior fellow, Caroline Freund, at the Peterson Institute of International Economics (PIIE).

International trade rules, which are overseen by the WTO, only allow border adjustments on indirect taxes such as sales tax and value added tax on products. Such taxes ensure that the tax system is destination-based, so that anything that you consume in-country is only taxed in that country – meaning domestic and foreign producers face the same tax rates within any given country, she explains.

European Commission (EC) vice-president for overseeing EU trade policy, Jyrki Katainen, told the Financial Times in an interview that Europe did not want a trade war with the US but that it was prepared to act if necessary.

“If somebody is behaving against our interests or against international rules in trade then we have our own mechanisms to react. We have all the legal arrangements within the EU, but we are also part of global arrangements like the WTO and we want to respect the global rule base when it comes to trade,” he said.

Under the proposal, depending on how goods are made, different companies and sectors would face varying tax rates. Companies that make products entirely domestically will face a lower tax rate, while companies that bring in completely imported goods will face an up to 20% rate. This policy is in line with the protectionist standpoint that the Trump administration has been pushing.

According to PIIE, the new tax will raise around US$100bn a year, which will help alleviate the substantial cut in revenues from the proposed cuts to corporate tax rates, which are aimed at preventing companies from wanting to shift profits to lower tax locations overseas.

Supporters of the new proposal see it as a way of addressing WTO rules that allow countries with VAT-based systems to offer rebates on exports while income-based systems, like the US, cannot do the same. Critics however argue that the move could lead to a retaliation and countries would be free to then raise tariffs against US-made goods. The proposals have resulted in a serious corporate lobbying battle between big importers and exporters.

The US made a similar move to allow export rebates in the 1990s, which was challenged by the EU and struck down by the WTO.