Ireland allows generous tax relief for cash donations to charities but only if they are registered in the state, something which the Department of Finance says is absolutely necessary "on grounds of public policy and public security."

Charities or approved bodies which can benefit from tax breaks are regularly checked by Revenue to ensure they are genuine. But because many other EU countries do not operate the same rules, there is no way of checking on them if they are based outside the country.

There is no limit to the amount that can be donated tax free and there have been cases of up to Euro1m being handed over. Revenue has to have these charities close by so it can check whether or not exchequer funds are falling into criminal hands, a spokesman said. The EU describes this approach as discrimination and says it is contrary to the freedom of movement and capital enshrined in the EC treaty.

Two years ago, the EU Commission ordered all member states to closely monitor nonprofit organisations or charities to counteract abuse by terrorists. "There is evidence that non-profit organisations have been exploited for the financing of terrorism and for other kinds of criminal abuse, " it warned, adding that "tax authorities should carry out effective and regular tax audits of non-profit organisations receiving special tax treatment."

But now Brussels is ordering Ireland to concede the same tax breaks to foreign-based charities, even though it is impossible to monitor or audit such charities.

The government has opened talks with the EU Commission to explore ways around the impasse, but a finance spokesman confirmed that it is contesting the commission's case. "We don't want to end up in court but we may have to."