BERLIN (Reuters) -Volkswagen's first-quarter earnings fell far short of market expectations, plunging about 40%, as Europe's biggest carmaker factored in costs for penalties of missing EU carbon emissions targets and for cars affected by U.S. tariffs.

Volkswagen's shares were up 8.2%, as relief swept through markets after the U.S. administration's announcement of a 90-day pause on tariffs imposed less than 24 hours earlier on dozens of countries, but a 25% tariff on autos imports remains in place and Volkswagen is heavily exposed.

Europe's autos index was up 4.9% at 0814 GMT, while a wider European index rose 7.9%.

After lobbying from the car sector, the European Commission, the EU executive, has proposed to loosen rules that most of the industry is likely to breach this year, leading to billions of euros in fines.

The proposal, which would give Volkswagen and the rest of the industry more time to boost sales of low emission electric vehicles, has yet to be approved by the European Parliament.

As a result, Volkswagen included a 600 million euro ($658 million) provision for potential fines in its first-quarter result, as well as 200 million euros for restructuring at its software unit Cariad, which is in the midst of layoffs.

That lowers its operating return on sales to around 3.6%, down from 6% last year.

A spokesperson declined to provide detail on the costs related to US tariffs.

Those linked to the valuation of vehicles in transit to the United States, where a 25% import tariff was imposed from April 3, weighed on results.

The bulk of the VW brand's U.S. sales is from cars made in Mexico and its Audi and Porsche brands have no U.S. manufacturing base.

The company confirmed its full-year outlook of up to 5% sales growth and operating return on sales of between 5.5% and 5.6% but said in its results statement these forecasts excluded the possible impact of tariffs since it was too early to assess their impact.

($1 = 0.9113 euros)