Britain broke European Union law in the way it taxed cross-border dividends, the European Court of Justice ruled yesterday.

The decision could force the Treasury to pay back hundreds of millions of pounds in rebates to multi-nationals.

"A member state must treat the payment of dividends at national and cross-border level in the same way if the situations are comparable," the court declared.

In the latest in a series of rulings on tax - a politically sensitive area jealously guarded by national governments - the court also accepted that any time limit on claims relating to the ruling would depend on the domestic law of individual countries.

Last week, Chancellor Gordon Brown sought to limit any clawback period to six years from the time the tax was paid, a decision that itself could be challenged in the courts. "We are still looking at a fair number of claims out there, but there are millions rather than billions of euros at stake," said Chas Roy-Chowdhury, head of tax at the Association of Chartered Certified Accountants.

The Government had suggested that rebates could run into billions.

"We are examining the judgment and we will comment in due course," a Treasury spokesman said.

The beneficiaries would be companies and shareholders, said Chris Morgan, head of the international tax group at KPMG.

"The amount is very difficult to work out. It will have to go back to the UK courts to implement it," he said.

The test case before the court centred on dividends paid to BAT from its subsidiaries elsewhere in the EU.

Dividends received from non-resident subsidiaries were subject to British corporation tax, while those from subsidiaries based in Britain were exempt.

In addition, if the company then distributed the foreign dividends to its shareholders, they used to be subject to advance corporation tax - now abolished by Mr Brown - while dividends from a UK subsidiary were effectively exempted by ACT credits.

BAT had argued that the British tax regime hindered the freedom to set up shop anywhere in the EU, a guiding principle of the EU's single internal market.

The Institute of Directors pointed out that the tax involved amounted to just one per cent of that paid by British companies.

"If the Government chooses to exempt all dividends received by companies, the UK's attractiveness as a location for group holding companies will shoot up," said Richard Baron, head of tax at the IoD.

In a separate case, the court said Britain's treatment of corporate dividends paid by a British company to an overseas subsidiary complied with EU law.

That case was brought by the Italian tyre company Pirelli, the French optics maker Essilor, the German car builder BMW and the Japanese electronics heavyweight Sony.

These argued they were in a less favourable tax credit situation, but the court disagreed.