The cost of carbon offsets is set to increase by almost a fifth after it emerged the Treasury is planning to level VAT on voluntary offsets.

Voluntary offsets are currently exempt from VAT with many being treated as charitable donations, but according to reports in The Observer, the government's new best practice code for the offset industry will see the top rate of VAT levelled on each carbon credit bought.

The Observer reported that Defra, which is responsible for developing the new standards designed to eradicate sharp practices across the embryonic offsetting industry, had requested that carbon credits continue to be exempted from the tax. But it is believed that the Treasury insisted it is obliged to level VAT on offsets under EU regulations that claim any " service" must face the levy.

A Treasury spokesman claimed that no final decision had been made on whether or not VAT would be applied to offsets, but he reiterated that under EU law VAT applies to the provision of services and that as a result the way certain offset schemes were structured and marketed meant they could qualify for the levy.

Offset charities and the travel industry have reacted angrily to the prospect of a tax on voluntary carbon credits, claiming such a tax would discourage people and companies from buying offsets and hamper growth in the industry.

It is estimated that £8m was spent offsetting UK emissions last year and the sector is growing rapidly with high-profile firms such as Sky and HSBC investing in offsetting all their emissions.

A spokesman for travel association ABTA said that taxing offsets would "put people off from investing in the schemes", and also raise serious questions about how the money raised from such a move would be spent.

"If you are taxing offsets, you have to ask where will the money go," he said. "Will it go on environmental projects as well? The government won't break out how taxes are spent, so there is no way of knowing."

However, Jonathan Shopley, executive director of offsetting provider The CarbonNeutral Company, welcomed the Treasury's plans claiming they would help create a level playing field for the offsetting industry.

"The CarbonNeutral Company has always charged VAT on its offsets but this is not the case for all offset providers," he said. "We believe it is really important for DEFRA and HMRC to set the rules in a way that reflects EU regulations – whatever those may be – and provides a level playing field for all offset service providers."

Shopley did however add that he would support any attempts to impose an EU wide VAT exemption for carbon offsets. "Whether we like it or not, as a service, [offsets are] subject to VAT rules as set by the EU," he explained. "If we want this to change, the UK Government will need to approach the EU and have carbon offsetting zero rated for VAT. We support this and believe it would be good news for everyone – and for the environment."