Telecoms regulator Ofcom has ordered BT to legally separate from its Openreach division, which runs the UK's broadband infrastructure.
Openreach should become a distinct company within the BT group, the regulator said.
BT had not voluntarily addressed competition concerns Ofcom laid out in July, it said.
However, BT said its proposals were "fair and sustainable", and that it would continue negotiating with Ofcom.
The regulator said it was preparing a formal notification to the European Commission to start the separation process.
Ofcom has resisted calls to split Openreach off entirely, which telecoms rivals have sought.
Ofcom said BT had not gone far enough to address its concerns about BT's ability to favour its retail business when making investment decisions in Openreach.
It wants Openreach to become a distinct company with its own board, with non-executives and a chairperson not affiliated with BT. It also wants Openreach to have control over its branding and budget allocation.
Openreach would also have a duty to treat all of its customers equally, the regulator said.
On Monday, BT had appointed Mike McTighe - who was on the board of Ofcom between 2007 and 2015 - as the first chairman of Openreach.
BT said in a statement: "We put forward proposals in July that we believe are fair and sustainable, and that meet Ofcom's objectives without disproportionate costs.
"We are implementing these proposals, and have just appointed Mike McTighe to be the first chairman of Openreach. We are in discussions with Ofcom on two outstanding issues, the reporting line of the Openreach chief executive and the form of legal incorporation.
"We will continue to work with Ofcom to reach a voluntary settlement that is good for customers, shareholders, employees, pensioners and investment in the UK's digital future."
The Department for Culture, Media and Sport said Openreach "needs to offer genuinely fair and equal access to the country's telecoms infrastructure to BT's competitors" and that it supported Ofcom action to achieve this.
BT's rivals, including Sky and Talk Talk, had complained bitterly about the service they received from Openreach, saying it charged too much for the use of broadband lines and was unresponsive to their demands. They wanted a full break-up of BT, with Openreach being turned into a separate company.
Ofcom has come some of the way, with Openreach now to become a legally separate entity, with its own independent board. But crucially it will still be owned by BT. Telecoms experts say the devil will be in the detail - how much control will BT be able to exert over Openreach under the new structure?
Sky and Talk Talk will be watching for any signs of too much influence - but if BT has no say at all over Openreach, it may in the end decide to break itself up anyway.
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