Plans for an independent tribunal amount to an admission of failure by the West to hold its ethnic Albanian allies accountable for war crimes.
The rebels had the backing of NATO during the war - and the West has staunchly supported Kosovo in its efforts to emerge from the conflict as an independent state.
But the ethnic Albanians have also come under increasing pressure from the international community to reckon with their own war crimes, including alleged organ harvesting.
The court is expected to start proceedings by next year, a senior EU official told The Associated Press, adding that the rules and reach of the tribunal are still being discussed with Kosovo authorities.
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The court is to be symbolically seated in Kosovo, but most key proceedings such as hearing witness testimony would take place in the Netherlands, said the official, who spoke on condition of anonymity because the deal has yet to be approved by Kosovo's assembly.
Former rebels are considered by many Kosovars as heroes who fought for freedom from Serbia. Some 10,000 people died during the 1998-1999 war and about 1,700 are considered missing.
The court, which will be set up and paid for by the EU, is to consider allegations of organ harvesting by the now-disbanded Kosovo Liberation Army rebels as well as the disappearance of some 400 people - most of them Kosovo Serbs - at the end of the war.