The organisation's national policy chairman Mike Cherry has written to the EC's directorate general for taxation and customs union on behalf of the FSB's 213,000 members in the UK outlining why the EC must act on the issue.
Cherry said that the UK's application of LVCR - a tax mechanism originally introduced to protect flower growers in the Channel Islands, which allows goods under the value of £18 to be imported into the UK without paying VAT - has created "a huge distortion of competition in relation to internet retail, which is all the more damaging as internet usage accelerates and business become more reliant up on it".
The letter cites the example of one independent computer games retailer who has found it hard to compete against mail order firms operating from the Channel Island as they are able to offer cheaper prices thanks to LVCR, a similar situation to that experienced by many indie music retailers in the UK
Cherry added, "The UK authorities have failed in their duty to protect UK small business from the abuse of VAT since the UK Authorities lax application of LVCR and acceptance of circular shipping has resulted in small firms being unable to compete with large retailers, who have been able to set up operations in the Channel Islands and avoid VAT on goods intended for consumption within the EU/UK.
"The distortion of competition caused by the UK Authorities inaction has created a severe imbalance forcing those who have to pay VAT out of business as they are unable to compete with those able to avoid VAT offshore."
And he called on the EC to take "firm action" to ensure that the UK stops the abuse of LVCR and create a level playing field for all retailers.
Richard Allen, whose own Delirium Mail Order company closed in 2007 following competition from online retailers, is spokesman for Retailers Against VAT Avoidance Schemes.
He welcomed the FSB's move. "The FSB's comment on this issue recognises that the primary determinant of whether a business in one of the affected trades succeeds is now not the quality of its product, nor its status as a small or large, high-street or online business, but whether it can avoid charging VAT," he said.
The FSB's move comes after Treasury minister Lord Sassoon told the House Of Lords the Government is "actively reviewing the operation" of LVCR, adding, "Ministers hope to be in a position to announce any possible changes to the operation of LVCR flowing from the review in the Budget on March 23."
Allen said, "An initially harmless European Tax relief is being exploited for a purpose totally contrary to its intentions. We hope that the UK Government uses the budget to end this dishonest avoidance scheme once and for all."