* Penalties for biofuels' indirect emissions removed
* New limit on use of crop-based biofuels remains
* Commission to formally present draft rules Wednesday
BRUSSELS, Oct 16 (Reuters) - The European Commission has watered down proposals to reduce the indirect climate impact of biofuels, but is sticking to a strict new limit on the amount of food crops that can be used to make fuel, EU sources said on Tuesday.
The late changes mean that fuel suppliers will not, as originally planned, be held accountable for the indirect emissions biofuels cause by displacing food production into new areas, resulting in forest clearance and peatland draining - known in EU jargon as ILUC factors.
"The 5 percent limit is still in, but the ILUC factors are now purely for reporting purposes and not part of the sustainability accounting rules for biofuels," one EU source involved in the discussions said.
The plan to limit the use of crop-based biofuels to 5 percent of total EU transport energy demand by 2020 represents a virtual halving of the EU's existing goal for a 10 percent share of renewables in transport by the end of the decade.
A Commission source, who also spoke on condition of anonymity, confirmed that the proposed indirect land use change (ILUC) emission factors for biofuels made from cereals, sugars and oilseeds would carry no legislative weight.
As a result, fuel suppliers will be free to continue blending biodiesel made from rapeseed, palm oil and soybeans into their fuels and claiming credit for cutting emissions, despite EU scientific studies showing that overall emissions from biodiesel are higher than fossil fuel.
The change is a victory for European biodiesel producers, who had said the Commission's original proposal would wipe out their industry practically overnight.
But the move could harm ethanol producers, who had been expected to increase dramatically their share of the EU biofuel market from a current 20 percent, at the expense of dominant biodiesel.
The Commission will formally present its proposals on Wednesday, after which the rules must be jointly agreed by EU governments and lawmakers in a process that could take up to two years. (Reporting by Charlie Dunmore; editing by Rex Merrifield)