The EU is set to finally ban illegal timber in 2012 after protracted legal wrangling over the issue.
After two years of negotiations, legislators reached a compromise on a deal that will require companies to trace where their timber was harvested.
Up to 40% of the world's wood production is estimated to come from illegally logged tropical forests.
MEPs will vote on the proposal in July before it is presented to the European Council in the autumn.
Members of the European Parliament and the European Council on Wednesday reached a provisional agreement that there should be a "prohibition" on illegal timber in the EU.
The plans also set out the responsibilities along the supply chain, and say companies will have to carry out risk assessments and use "due diligence" systems in areas where illegal activies are suspected.
"Substantial penalties would apply in cases of non-compliance, which could be calculated on the basis of environmental damage caused," the European Parliament said in a statement.
The Finnish Green MEP who steered the legislation through the parliament, Satu Hassi, welcomed the agreement.
"I am delighted that the Parliament was able to secure fundamental improvements to the draft regulation on illegally harvested timber," she said.
However, timber used to produce printed material such as books and newspapers will be exempt for a further five years.
Illegal logging is a major driver of deforestation, with the volume of industrial wood from illegal sources estimated at 350-650m cubic metres each year.
Although certification schemes do exist, experts say that in many regions, just as much timber is logged illegally as legally, making it very difficult for consumers to make an ethically based choice.
Illegal logging is blamed for depressing timber prices, strips natural resources and tax revenues, and increases poverty of people who depend upon forests.
"The world's largest market is about to shut its gates to companies profiting from illegal trafficking and forest destruction," said Sebastien Risso, forest policy director for Greenpeace EU.
"The black market for wood products is often run by criminals fuelling conflict, robbing governments of revenue and causing irreversible environmental destruction."