Retailers, such as Play.com, Tesco and Amazon, have increasingly used the Low Value Consignment Relief (LVCR) rule to avoid paying VAT on products sold online.
However, the LVCR will no longer apply to all goods sent from the Channel Islands from April 1, after the government found that it was costing £140m a year.
The maximum price of goods allowed under LVCR was also reduced from £18 to £15 on November 1, following a Budget announcement in March.
"These reforms will ensure that UK companies, especially small and medium-sized enterprises, can compete on a level playing field with those larger companies with the resources to set up operations in the Channel Islands," said David Gauke, exchequer secretary to the Treasury.
"We are also protecting a significant amount of tax revenue. By making these changes, we are striking the best possible balance between the costs of collecting small amounts of VAT and protecting the interests of UK taxpayers and businesses."
LVCR was originally implemented as a VAT exemption for goods coming to the UK from outside the EU, as previously collecting small amounts of VAT cost more than it was actually worth.
The problems arose because the Channel Islands are treated as being outside of the EU for VAT purposes, enabling retailers to send low-price goods to the islands and have them sent back individually to the UK.
Richard Allen, a spokesperson for Retailers Against VAT Avoidance, said that businesses would welcome the removal of this "major market distortion".
"The VAT Loophole is not only contra to the basic principles of EU VAT law but is also contra to any sense of fair play and a 'moral market'," he said.
"Although we welcome competition based on price and service, a scheme that abuses tax legislation in order to promote damaging and predatory competitive behaviour should never have been allowed to develop.
"We hope that the UK Government and EU will now remain vigilant and ready to close down any similar schemes should they develop in other locations. The Channel Island's VAT loophole has over many years destroyed livelihoods and caused much misery in the UK business community."
Officials in Jersey and Guernsey have warned that the change would have a "significant impact" on the islands. They are concerned about the amount of notice they were given about the move, which could put up to 1,700 jobs at risk across the islands.
However, Allen said: "We are of course sympathetic to those Channel Island employees who may lose their jobs as a result of the ending of this industry but we think it is entirely disingenuous for commentators to blame the loss of that employment on those attempting to correct what is clearly an unacceptable, unsustainable and damaging abuse of the tax system."
In 2009, the government uncovered an error in legislation that meant measures preventing the sale of adult videos and video games to under-18s were actually unenforceable. The loophole has since been closed.