Controversy over the Internal Market Bill has thrown the tortuous Brexit process into a new crisis while disagreements over corporate subsidies, fisheries and ways to solve disputes overshadow paralell trade negotiations.

"We had invited our British friends to remove the problematic parts of their draft Internal Market Bill by the end of September," the head of the EU's executive Commission, Ursula von der Leyen said on Thursday.

"The deadline lapsed yesterday."

With London not budging, she said the Commission started a so-called infringement, an EU legal procedure against countries that violate the bloc's laws.

"At the same time, the Commission will continue to work hard towards a full and timely implementation of the Withdrawal Agreement. We stand by our commitments," von der Leyen said.

London now has one month to reply to the Commission's formal letter of complaint and even more time to change tack before the Brussels-based executive can sue at the bloc's top court. The case could lead to hefty fines, but that takes years.

But sterling slipped 0.6 per cent against the euro and the dollar after the case was announced. "A no-deal is looking more likely," said Neil Jones, head of FX sales at Mizuho, who predicted further falls.

Britain's lower house of parliament approved the Internal Market Bill on Tuesday and it is now with the House of Lords.

The UK says ensuring that its nations can trade freely with each other after Brexit would require breaking the divorce deal provisions on the sensitive Irish border.

A UK government spokesman said in reacting to the news from Brussels that Britain has "clearly set out reasons" to change its Brexit treaty provisions.

The EU is adamant, however, that it would not implement any new UK deal as long as London undermines the divorce treaty.

Talks on the new trade agreement are nearing crunchtime.

Senior UK minister Michael Gove said "differences still remain" between Britain and EU in trade discussions, but that London would work hard for a deal.

EU officials and diplomatic sources told Reuters negotiators had failed to close the gap on the key issue of state aid.

The EU wants London to agree to broad state aid rules compatible with its own. The bloc wants an independent British regulator to decide on state aid there, as well as a new EU-UK dispute settling mechanism that would create a new Joint Committee and an Arbitration Panel to adjudicate.

Should one side fail to honour decisions made through that process, the Arbitration Panel could impose fines and the other side could retaliate by hitting bilateral trade elsewhere.

An EU official involved in the talks told Reuters: "It remains to be seen if the UK can sign up to that ... We haven't got there yet. Not sure we'll ever get there."

Britain wants control of its subsidy regime and says state aid clauses are not usually put in free trade agreements.

The EU says a deal must be at hand by early November to give the European Parliament and some national parliaments enough time to ratify it before Britain's post-Brexit transition expires at the end of the year.

Australian Associated Press