The European Commission is expected to start infringement proceedings against Ireland next Wednesday over the Government's failure to notify it of continuing special capital and rent or rate allowances to companies in the International Financial Services Centre (IFSC) since 1993.

But the Commission is also likely to signal its approval of the continuation, and extension by an extra 12 acres, of the special capital allowances provisions. This is to reassure major financial groups such as AIB and Citibank, which are already building some 400,000 sq ft of extra office accommodation on the neighbouring site.

There are serious concerns that the double rent and rates allowances will be found to be illegal and the Government is hoping to stave off a retrospective ruling by the inquiry that the value of the latter allowances since 1993 should be repaid by businesses. The Government will argue that companies should not be penalised for what was an "honest administrative error" rather than a deliberate attempt to circumvent obligations.

If repayment is required, despite the apparent negligence of the Government in failing to reapply for permission for the aid schemes, a Commission spokesman insists that the companies will not be able to sue the Government for damages. This is because the principle of legitimate expectations is held not to apply in state aids cases. In the past, the failure of a member-state government to renotify a state aid to the Commission could have been dealt with through a private exchange of letters and an apology. Those times have changed.

Now member-states are acutely sensitive to the tax breaks being offered to mobile international business - a sensitivity sharpened in the Republic's case by a sense that the State is doing particularly well by such means.

These days the Commission has to be particularly scrupulous to ensure that every procedure is followed to the letter.

That newer sensitivity has been matched by the Commission's major overhaul of its state aids policy in an effort to cut back substantially on what are seen as serious distortions to the market. Such distortions are said to strongly favour the richer states.

The new guidelines for aid distinguish sharply between capital and operational or day-to-day spending aid, which the Commission wants to eliminate (with the specific exception of transport to ultra-remote areas).

States will still be allowed to give capital grants or their equivalent in tax breaks, up to a certain level, in the poorer Objective 1 areas, but subject to notification and approval by the Commission.

The new policy makes it extremely unlikely, Commission sources say, that the Government will be allowed to continue any form of rent or rates relief, a reality which diplomats acknowledge.

A Commission spokesman said that the same logic was expected to be followed in the Government's separate applications regarding the Dublin convention centre scheme and the special urban initiatives planned for Galway, Cork and Sligo. Consideration of these applications is ongoing.