By Byron Kaye and Jonathan Barrett

SYDNEY (Reuters) - Facebook Inc <FB.O> on Tuesday said it would stop Australians sharing news content on its platforms if a proposal to make it pay local media outlets for their content becomes law, escalating tension with the Australian government.

The world's largest social network also updated its "terms of use" on Tuesday to say that it can block content anywhere globally or restrict users from accessing the services if such a move is warranted to avoid regulatory risks.

"This global update provides more flexibility for us to change our services, including in Australia, to continue to operate and support our users in response to potential regulation or legal action," a company spokesperson said.

Under Australia's closely watched internet reform, the country will become the first to make the social media behemoth and Alphabet Inc's <GOOGL.O> Google pay for news sourced from local providers under a royalty-style system.

Facebook's plan to block the sharing of news on Australian user accounts, rather than pay royalties, puts the firm broadly in step with Google on the matter and pushes the prospect of an agreement with the government further out of reach.

"Assuming this draft code becomes law, we will reluctantly stop allowing publishers and people in Australia from sharing local and international news on Facebook and Instagram," Facebook Australia Managing Director Will Easton said in a blog post, referring to two Facebook-owned platforms.

"This is not our first choice - it is our last. It is the only way to protect against an outcome that defies logic and will hurt, not help, the long-term vibrancy of Australia's news and media sector".

Australian Treasurer Josh Frydenberg on Tuesday said the proposed law was in the national interest, followed 18 months of public inquiry and would create a more sustainable local media industry where original content was paid for.

"We don't respond to coercion or heavy handed threats wherever they come from," Frydenberg said in an emailed response to Reuters' request for comment.

Australian Competition and Consumer Commission (ACCC) Chair Rod Sims, who is overseeing the proposed law, said Facebook's response was "ill-timed and misconceived", and that the proposal "simply aims to bring fairness and transparency to Facebook and Google's relationships with Australian news media businesses".

"As the ACCC and the Government work to finalise the draft legislation, we hope all parties will engage in constructive discussions," Sims said in a statement.