The Government is considering proposals which would allow the tax exemption on stallion stud fees to continue in a limited form.
Minister for Finance Brian Cowen and Minister for Agriculture Mary Coughlan are considering options for the scheme's future, including allowing the tax exemption to continue for a set number of stallions every year.
Such a move could benefit small-scale horse breeders, but some in the industry have expressed concerns that such a measure could still lead to top stallions being sent abroad where more favourable financial conditions existed.
The European Commission has told the Government that it considers the existing tax exemption a breach of rules governing State aid.
It has said that the scheme, introduced in 1969 and which is believed to cost the Exchequer around €3 million annually, should be abolished.
The commission is understood to have said that only tax exemptions of up to €3,000 and limited to a three-year period would be acceptable under EU rules.
A spokesman for Mr Cowen said last night that the Government would respond to the commission in due course.
The Government is concerned about the consequences of a total abolition on the horse breeding sector.
Ireland has a significant horse breeding industry, and in addition to well-known international players, there are also small-scale horse breeders.
There are around 450 stallions based in Ireland and 16,000 mares, with up to 10,000 foals born annually.
Sources said that other countries, particularly France, were unhappy with the Irish tax scheme for stallions and had lobbied the commission on the issue.
The Government has had two meetings with the EU Agriculture and Rural Development Commissioner, Mariann Fischer Boel, since it raised concerns about the scheme some months ago.
A spokesman for the commissioner said last night that it seemed clear the stallion tax exemption scheme, in its current form, was against EU state-aid rules.
Last night the chief executive of Horse Racing Ireland, Brian Kavanagh, said it had drawn Government attention to the value of the breeding industry and had pointed out that many other countries had their own form of financial incentives.
He said that an independent report commissioned by it and the horse breeding industry had found the tax exemption scheme cost the Exchequer around €3 million annually, but that the sector contributed €350 million to the economy and the breeding industry paid €37 million in tax each year.
The Green Party last night welcomed the commission's decision to seek the abolition of the stallion tax exemption.
