The EU's chief Brexit negotiator Michel Barnier has said Theresa May's decision to leave the customs union will cause "unavoidable" barriers to trade.
Speaking after meeting with the prime minister and Brexit Secretary David Davis at Downing Street, Mr Barnier said "the time has come to make a choice".
He added that "without a customs union and outside the single market", barriers to trade in goods and services"are unavoidable".
Earlier, Downing Street insisted Britain will "categorically" be leaving the customs union after Brexit.
Mr Barnier also said the UK has to "play by the same rules" as the European Union during the transition period.
"The conditions are very clear, everyone has to play by the same rules during this transition."
"The certainty about this transition will only come with the ratification of the withdrawal agreement," he added.
Mr Davis hailed the latest talks as "constructive" and said the next round would focus on the implementation period.
"Our negotiating teams are starting straight away on an intensive period of negotiation and we're confident that we can get to that political agreement at the March economic council," he added.
Mr Davis also reiterated that the UK is "very keen" to continue to have an extremely good and close" relationship with the EU.
The Brexit Secretary insisted the UK wanted a comprehensive free trade agreement while still having the opportunity to make deals across the rest of the world.
"It's perfectly clear what we want to do. There's no doubt about it, we are leaving the customs union but we are aiming for a good future for Britain," he said.
Earlier, Mr Barnier said he would "respect the red lines" set out by Mrs May, but the UK must also "respect the rules of the union".
Hard-line Brexiteers have been exerting increasing pressure on Mrs May to be resolute about leaving the union when Britain exits the bloc on March 29, 2019.
The intervention by Number 10 came after apparent confusion at the top of Government over the approach to the issue.
But business leaders have urged the Government to remain in a customs union.
Guy Platten, chief executive of the UK Chamber of Shipping, said: "What we call the future customs relationship does not matter. What matters is that goods are able to move trade freely through ports without delay."
TUC general secretary Frances O'Grady said: "By ruling out a customs union, the Government is choosing to put up barriers to UK trade with Europe. It will be bad for jobs, bad for investment and bad for business.
He added: "The best way to protect jobs, investment and rights at work is through the single market and customs union."
The latest meeting was the first time the trio have met since EU officials gave the green light in December to moving ahead to this stage of talks.
But since then European leaders have insisted that EU law must continue to apply in the UK throughout the transition period - expected to last around two years.
Mrs May has already signalled that she will fight the bloc's demands that EU citizens who come to the UK during the transition should enjoy the same rights as those arriving before March 29, 2019.
And ministers have said the demand exceeds what was agreed at December's summit in Brussels.
The European Parliament's Brexit co-ordinator Guy Verhofstadt has insisted the stance is "not negotiable".
And Tory backbenchers have also been critical of the government for agreeing that any changes to EU law which are passed during the transition will apply in the UK.
Monday's meeting will be followed on Tuesday by the first technical discussions by UK and EU officials in Brussels on the transition arrangements intended to ensure businesses and citizens are not faced with a "cliff edge" break when Britain leaves the bloc.
Meanwhile senior ministers are also preparing for the first discussions on Britain's future relationship with the EU by Mrs May's so-called "Brexit war cabinet".
Members of the Cabinet Brexit sub-committee will meet on Wednesday and then again on Thursday as they seek to thrash out an agreement on thorny issues like customs arrangements with the remaining EU27.