Tesco has quietly returned to a multimillion-pound Channel Islands tax dodge four years after the authorities in Jersey banished the supermarket group's VAT-free CD and DVD website from the island, accusing Britain's largest retailer of operating a "sham" selling structure that brought the Channel Islands into disrepute.

The Tesco Entertainment website is now offering online VAT-free sales of CDs and DVDs from Guernsey, the Guardian has learned. The tax avoidance involved may be unclear to many customers, however, as the site's small print simply states: "All prices are expressed inclusive of any VAT payable unless otherwise stated."

The move is likely to prove embarrassing for the British government which has sought to dismiss suggestions this VAT loophole trade is ballooning out of control. In February the Treasury issued a statement attacking Guardian claims that intense price competition had led to online VAT dodging had become the industry norm. "The implication that businesses are simply setting up on the Channel Islands to take advantage of this relief is not true," officials said.

Told of Tesco's low-key return to Channel Islands VAT avoidance, Liberal Democrat Treasury spokesman Vincent Cable said: "It seems to me absolutely extraordinary and seriously unwise for a leading British plc to be caught out dodging tax at a time when the country has a very serious fiscal crisis on its hands. I am sure if they are sufficiently aware of the importance of their reputation in this area that they will stop it immediately."

Treasury minister Stephen Timms has estimated the cost in lost VAT revenues from all companies involved in this trade for 2008 was £110m and rising, implying annual VAT-free sales of £625m. To qualify for tax exemption under EU rules, goods must be imported from outside the EU at a price of less than £18. As well as Tesco, other big name retailers to exploit the loophole include Amazon, HMV, WH Smith, Play.com and Asda.

In its earlier guise, Tesco's Channel Islands website was candid about its activities. The site was branded "Tesco Jersey" and customers were clearly told: "It is cheaper to buy this product from Tesco Jersey because no VAT is included." This frank approach made Tesco a target for campaigners, led by small independent music stores who were unable to compete with VAT-free prices.

Four years ago, Tesco and a small number of competitors were driven out of Jersey by the island's then economic development minister Philip Ozouf, who imposed a new licensing regime designed to curb VAT-dodging activities. "We don't want the economy dominated by online retailing," he said, promising businesses would be stopped from "simply using Jersey as a postbox".

In a 2006 letter to those being pushed off the island, Jersey officials wrote: "The minister [Ozouf] is concerned that Jersey is being used as part of a selling structure which is a complete sham, inasmuch as the purchaser and the parent company of vendor are both located in the UK, and even the goods, or some of them, are transferred to Jersey from the UK for the sole purpose of being the subject of a token sale in Jersey before being shipped back to the UK and delivered to the purchaser."

In a Commons debate in January last year, Treasury minister Stephen Timms said: "Guernsey has made it clear to a number of UK companies involved in music retailing, including those that have been forced to close their Jersey operations, that it does not wish to see them establish activities on the island."

Despite pressure on public finances, the drive to close the VAT loophole has all but disappeared. In his 2006 budget, Gordon Brown said: "The government is aware that [EU VAT relief rules on imports] is currently being exploited and the relief now costs the exchequer around £85m per year. If the relief continues to be exploited by businesses using offshore locations, the government will consider changes to prevent this type of behaviour."

Customers using Tesco's website today will be told that they may be buying from Tesco (Jersey) Ltd, a company registered to an address in St Helier, the island's capital. Until recently, Tesco had recruited a third-party company, TheHut.com, which has operations in Jersey and Guernsey, to enter into VAT-free transactions on its behalf through the Tesco Entertainment website. Tesco (Jersey) Ltd is now entering into these transactions directly.

Asked if the company had a Jersey licence for such trades, Tesco said: "We are trading from Guernsey so do not need a Jersey licence." It added: "Like a number of other online retailers, Tesco Entertainment operates from Guernsey. We have to remain very focused on price in this fiercely competitive market. The benefits from the VAT savings are passed straight to customers in the form of a lower price."