By Kate Abnett

BRUSSELS (Reuters) -The European Union is set to demand that cars running on e-fuels must be 100% carbon neutral if they are to be sold beyond 2035, a draft document showed, after Germany demanded e-fuel cars be exempted from the phase-out of new polluting vehicles.

All new cars sold in the EU from 2035 must have zero CO2 emissions, under the EU's main climate policy for cars, which countries agreed earlier this year.

However, the European Commission is developing a legal route for sales of new cars that only run on e-fuels to continue after 2035, after Germany demanded this exemption.

A draft EU legal proposal, seen by Reuters, showed Brussels plans to set strict conditions for e-fuel cars - requiring them to run on fully CO2 neutral fuels.

E-fuels are considered carbon neutral when they are made using captured CO2 emissions that balance out the CO2 released when the fuel is combusted in an engine.

The draft rules would be stricter than the low-carbon fuel rules in some other EU climate policies. For example, countries can use certain fuels to meet EU renewable energy targets if they achieve a 70% emissions saving, rather than 100%.

Neither the Commission nor Germany's transport ministry immediately responded to requests for comment.

The eFuel Alliance industry group said the draft proposal would effectively ban new combustion engines from 2035, if it counted emissions along the value chain as well as those from producing an e-fuel.

"A 100% reduction in emissions is therefore nearly impossible," Ralf Diemer, the group's managing director, said in a statement on Friday.

The draft rules would form a legal basis for carmakers to register a new type of vehicle - a combustion engine car that runs exclusively on carbon neutral fuels.

Such vehicles must be designed so that the engine would not start if the vehicle is fuelled with CO2-emitting petrol, under the draft rules, which could change before they are due to be published later this year.

Manufacturers would need to enforce this using technologies such as devices that track the chemical properties of the fuel. They would also need to develop rules to make sure these technologies cannot be tampered with, the document said.

(Reporting by Kate Abnett, additional reporting by Riham Alkousaa in Berlin; editing by Philip Blenkinsop and Miral Fahmy)