Cadbury Schweppes yesterday seemed to suffer a setback in its attempt to challenge the tax treatment of two Irish subsidiaries.

The world's largest manufacturer of confectionary and soft drinks claims that the British government has breached European Union law by not allowing it to benefit from Ireland's lower taxes.

It is disputing an £8.6 million tax bill for 1996.

But the advocate general, an adviser to the European Court of Justice, said in a preliminary ruling that UK tax rules on overseas subsidiaries do not breach European Union law provided that they are intended to crack down on tax avoidance.

Tax experts said the opinion was a further example of the court taking a more even-handed approach by being sensitive to stretched national finances, rather than unconditionally favouring taxpayers as it often did in the past.

The opinion centred on a c omplaint by Cadbury Schweppes that Britain's "controlled foreign company" (CFC) tax rules were incompatible with EU law and discouraged firms from setting up shop abroad.

Cadbury Schweppes has two subsidiaries in Ireland to raise finances for the group's operations.

The advocate general said that setting up a subsidiary in another member state to benefit from a low tax rate did not constitute in itself an abuse of EU rules on freedom of establishment.

But a member state can act in the public interest by hindering the freedom of establishment to stamp out tax avoidance.

"In the opinion of the advocate general, the United Kingdom legislation on 'controlled foreign companies' is compatible with community law if it applies only to wholly artificial arrangements i ntended to circumvent national law," the court said in a statement.

The advocate general said it was for the national courts to assess, using criteria put forward in the opinion, whether the overseas group had been set up to avoid tax.

The criteria look at the degree of physical presence in the country, the genuine nature of the activity, and the economic value of the activity to the group overall.

"I think it will be quite difficult for member states to prove something is wholly artificial," said Mark Persoff of law firm Clifford Chance.

"This again demonstrates the continued impact that the European Court of Justice is likely to have on member state tax systems and it's inevitable there will need to be some changes."

The advocate general's opinion is upheld in most cases by the full court.

" Assuming the court upholds these tests, I think the UK will be forced to recast its CFC rules," Mr Persoff said.

Other experts also noted the conditions laid down in the opinion.

"Clearly, they seem to be much more softly-softly in their approach rather than driving a coach and horses through national legislation," said Chas Roy-Chowdhury, head of taxation at Britain's Association of Chartered Certified Accountants.

Cadbury Schweppes yesterday said it would not comment on the case until a full ruling is issued.

But the company was understood to be optimistic that the ruling would ultimately be favourable.

"All we are looking for is a level playing field," a spokes-woman said.

A Treasury spokesman said: "We welcome the fact that the Advocate General has not found the UK's CFC rules contrary to EU law."