Online music fans will for the first time be able to legally share tracks by big names such as Oasis, Beyonce, David Bowie and Elvis Presley after the artists' record label signed a ground-breaking deal with a new internet service provider.

In what some see as signalling a dramatic shift in the way consumers buy music, the provider, Playlouder, has licensed acts from SonyBMG, the world's second largest record label, and is confident that the other two big record labels, Universal and EMI, will follow suit.

Illegal file sharing, which allows users of software such as Kazaa, Grokster and eDonkey to swap pirated tracks over the internet, has been blamed by the record industry for largely contributing to a 25% slump in global sales since 1999, worth around £1.3bn a year.

The record industry has pursued a "carrot and stick" approach, taking legal action against the worst offenders while encouraging the use of legal download sites such as Napster and iTunes.

In June, Sylvia Price, 53, of Cheltenham, Gloucestershire, was forced to pay £2,500 compensation for around 1,400 songs downloaded by her daughter, Emily, 14, on the family's home computer; and in March, 23 file sharers agreed to pay £2,200 each in compensation for uploading their music libraries on to the internet for others to copy.

Playlouder is offering the first legal alternative with a comparable experience to the "peer to peer" file sharing sites often used to swap pirated tracks.

Subscribers will be charged £26 a month for a high speed broadband internet connection, similar to the price charged by BT, with the added attraction of being able to share as much music as they want with other subscribers at no extra cost.

Because there will be no restrictions on the format in which the traded music is encoded, users will be free to transfer songs to any type of digital music player, including the market leading Apple iPod, or burn them to CD.

However, not only will consumers have to pay for music which they currently acquire free, albeit illegally, but they will also have to change their internet provider.

After signing the UK licensing deal with SonyBMG, whose acts also include George Michael, Bruce Springsteen and Dido, Playlouder's chief executive, Paul Hitchman, is confident that its big rivals will follow suit.

It has already signed deals with dozens of independent labels affiliated to the Association of Independent Music, representing artists such as the White Stripes, Franz Ferdinand and Dizzee Rascal. AIM's chief executive, Alison Wenham, said the idea was a "simple but radically different solution to the means of accessing music on the internet".

Because all Playlouder subscribers will share tracks over its own network Mr Hitchman said that the company could track the files and, through digital fingerprinting technology, make sure that record companies were remunerated accordingly from money set aside from Playlouder's revenues each month.

He said he believed that the service, to be launched next month, "could well be the most important development in digital distribution since the invention of the MP3 format".

Some record company executives have been wary of such deals because they fear it could reduce their ability to market big selling acts on a global basis. But conversely, it could also increase their revenues from back catalogue tracks.

Playlouder claims that if all ISPs adopted its model, the record industry would make an additional £300m a year in the UK alone.

Other companies, including one set up by the former Grokster president Wayne Rosso, have been working on legal versions of peer to peer file sharing. But Mr Hitchens claimed that while they would allow sharing, if customers wanted a high quality version, they would have to pay extra.

The British Phonographic Industry, which has imposed fines of up to £6,500 each on 60 file sharers found to be making thousands of pirated tracks available to others and is taking five more to court, welcomed the development.

"Ensuring record companies are adequately and reliably compensated for the use of their copyrights on the internet is the number one issue for our business," said the BPI's chairman, Peter Jamieson.