WASHINGTON — A trade war isn’t being threatened by the European Union, but a Monday ruling by the World Trade Organization against a U.S. law that gives tax breaks to businesses operating overseas is raising the possibility.

The U.S.-EU wrangling over the tax break has been simmering for a couple of years. In the latest turn, a WTO appeals panel upheld three earlier rulings that found the tax break to be an illegal export subsidy under WTO rules.

EU officials have the right to ask the WTO for permission to impose penalties on up to $4 billion of U.S. goods, including apparel and cosmetics, imported into the region. However, EU officials, per an agreement reached in September 2000 with the U.S., will now take the issue to arbitration.

However, EU Trade Commissioner Pascal Lamy urged a speedy resolution and said; “Now, it is up to the United States to comply with the WTO’s findings to settle this matter once and for all.”

At issue is a U.S. law that gives American companies tax breaks on profits made on the sale of goods or services made outside the U.S. The U.S. has argued that the exemption keeps foreign profits from being taxed both by the U.S. and foreign countries. Congress tried to appease the EU in 2000 with a change in the law, but the WTO rejected it.

U.S. Trade Representative Robert Zoellick said in a statement that the Bush administration will “continue to seek to cooperate with the EU in order to manage and resolve this dispute.”

Julia Hughes, vice president of international trade at the U.S. Association of Importers of Textiles & Apparel, said she hopes a trade war will be averted.

“It will be difficult to find a compromise Congress will support,” she said. “But noncompliance with the WTO could lead to the path of retaliation. We are urging the administration to come into compliance quickly with the WTO ruling.”