Britain's failure to protect its citizens from secret surveillance on the internet is to be investigated by the European Commission.

The move will fuel claims that Britain is sliding towards a Big Brother state and could end with the Government being forced to defend its policy on internet privacy in front of judges in Europe.

The legal action is being brought over the use of controversial behavioural advertising services which were tested on BT's internet customers without their consent.

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Yesterday, the EU said it wanted "clear consent" from internet users that their private data was being used to gather commercial information about their web shopping habits.

Under the programme, the UK-listed company Phorm has developed technology that allows internet service providers (ISPs) to track what their users are doing online. ISPs can then sell that information to media companies and advertisers, who can use it to place more relevant advertisements on websites the user subsequently visits. The EU has accused Britain of turning a blind eye to the growth in this kind of internet marketing.

Yesterday, the EU telecoms commissioner, Viviane Reding, said: "I call on the UK authorities to change their national laws and ensure that national authorities are duly empowered and have proper sanctions at their disposal to enforce EU legislation."

Last year, BT tested the Phorm technology to track its customer's internet searches without their knowledge, provoking complaints from users and from UK members of the European Parliament.

Because it is considered lawful to intercept data when there is "reasonable grounds for believing" there is consent, the issue falls outside the UK's wiretapping laws. Linda Weatherhead of Consumer Focus said: "While phone tapping is clearly illegal and unacceptable, it seems that spying on the digital communications and activity is not." Richard Clayton, treasurer of the Foundation for Information Policy Research (FIPR) – which described Phorm as "illegal" last year – said: "The laws are fit for purpose, but it seems that Whitehall have misunderstood their own laws." He said that users at both ends need to have consented to the system, which is not the case here and so contravenes the Regulation of Investigatory Powers Act from 2000.

The Commission is also critical of the Government's implementation of the European electronic privacy and personal data protection rules. They state that EU countries must ensure the confidentiality of communications by banning the interception and surveillance of internet users without their consent.

Ms Reding said: "We have been following the Phorm case for some time and have concluded that there are problems in the way the UK has implemented parts of EU rules on the confidentially of communications."

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She added that the enforcement of the laws "should allow the UK to respond more vigorously to new challenges of e-privacy and personal data protection such as those that have arisen in the Phorm case. It should also help reassure UK consumers about their privacy and data protection while surfing the internet."

The EU's intervention was welcomed by privacy campaigners. The Open Rights Group recently wrote to some of the world's biggest websites including Google, Yahoo and Facebook, asking them to block Phorm. Its executive director, Jim Killock, said yesterday: "There are big legal questions surrounding BT's use of Phorm, so we welcome the EU taking the Government to task. It's a pity our own Government haven't had more backbone and stood up for their voters' rights."

The UK has two months to reply to the EC's formal notification. Should no satisfactory response be made, the Commission could issue a reasoned opinion, before the case moves to the European Court of Justice.

Last year the Information Commissioner's Office passed the Phorm technology as legal.

Advertisers are particularly keen on this form of marketing as the more targeted it becomes, the more value for money they feel the advert offers. One consultant said: "It is basically a very fine line between advertising that helps people and those that intrude."

Phorm boss Kent Ertugrul has been increasingly forced on to the back foot over the issue of privacy, fending off a series of questions over the issue last week at a "town hall" meeting. He said that the technology does not store information to identify a user; that all participants can opt out of it; and that it complies with data protection and privacy laws. The group added yesterday that the Commission's statement did not contradict that its technology was fully compliant with UK legislation and EU directives.

It is illegal in the UK to unlawfully intercept communications, but this is limited to "intentional" interception, the EC said yesterday. This is also considered lawful when those intercepting have "reasonable grounds for believing" consent has been given. There is no independent national supervisory authority dealing with such cases.

Several bodies including FIPR have blamed the Government and the UK regulators for playing "pass the parcel" with the issue, which has left it hanging with no one wanting to enforce it.

The Commission received its first complaints over the issue in April last year following BT's trial. Other providers including Virgin and Carphone Warehouse's TalkTalk are also interested.

Users complained to the UK data protection authority and the police. The Commission wrote to the UK authorities in July and upon receiving the answers "has concerns that there are structural problems in the way the UK has implemented EU rules".

Simon Davis, director of Privacy International, believes the row has erupted more over "sovereignty than substance. It is almost entirely political".

'Big Brother' Britain: Private data under threat

* The mobile calls, emails and website visits of every person in Britain will be stored for a year under sweeping new powers which came into force this month. The new powers will for the first time place a legal duty on internet providers to store private data.

* Privacy campaigners warn that all this information could be used by the Government to create a giant "Big Brother" super-database containing a map of everyone's private life. The Home Office is expected shortly to publish plans for the storage of data which it says will be invaluable in the fight against crime.

* Facebook, one of the world's biggest internet sites, faced a privacy backlash when thousands of members signed a petition calling on the website to remove an advertising programme called Beacon, which can be used to track the spending habits of its users' visits to other websites.

* Google also courted controversy this year when it launched Street View, the controversial 3D mapping feature, in the UK. In one village householders stopped a Google vehicle from taking pictures of their street.