Victims of torture carried out with the knowledge of British agents could receive compensation, the Government has decided.
David Cameron is expected to announce a judge-led inquiry shortly into the long-running allegations that British intelligence officers were complicit in British residents being tortured by the security services of other countries.
The move could cause tension with the US, which had already hinted that the sharing of classified information with Britain could be put at risk if the work of its agents is put under the spotlight. Downing Street declined to comment on whether Mr Cameron told President Barack Obama about the inquiry when they met at the G20 summit last weekend.
Before the general election, both the Conservative and Liberal Democrats called for an investigation. Ministers from both parties hope the decision will clear the air after the repeated allegations and limit the spate of civil cases now being pursued in the courts. Compensation will be payable in cases where the inquiry finds someone was tortured and that British agents were aware of it.
The most high-profile case is that of Binyam Mohamed, who claims he was was tortured after being arrested in Pakistan in 2002. He was taken to Morocco and Afghanistan before being transferred to the US detention camp at Guantanamo Bay. He alleges that MI5 knew about his treatment and suggested questions to his interrogators through the CIA. He was released last year after charges of involvement in terrorist activity were dropped.
The independent inquiry may be unable to reach conclusions until a Metropolitan Police investigation into his case has been completed.
The judge who will head the inquiry, who is expected to be named this week, may be assisted by experts with experience of the security services. Some hearings will be held behind closed doors for national security reasons.
Lord Carlile of Berriew, the Government's independent reviewer of terrorism laws, said: "A judge-led inquiry will have the advantage of a rigorous investigation of allegations that are made, the protection of national security and the award of compensation to anyone who's able to prove on the balance of probability that they have been tortured or otherwise subjected to inhuman or degrading treatment."
David Davis, the former shadow Home Secretary, said: "It is vital that such an inquiry is led by a senior and impartial judge who is able to establish the facts beyond any doubt, to remove this stain on Britain's reputation, and to ensure that such allegations can never be made again. To do this he must have unfettered access to all the people and papers related to this matter and should be able to publish anything he thinks is in the public interest."
Last night human rights groups welcomed the Government's move. Shami Chakrabarti, director of Liberty, said: "Only this kind of inquiry can end the slow bleed of embarrassing revelation and expensive litigation and draw a line under this shameful business once and for all."
Clare Algar, executive director of the legal action charity Reprieve, said the inquiry should be as open and transparent as possible. "Torture, and complicity in torture, is morally repulsive, counterproductive, and illegal under both national and international law, and these allegations are, sadly, too numerous to ignore. We cannot learn from history and avoid repeating our mistakes if we do not know what that history is," she said.
Sir John Scarlett, the former head of MI6, said last year there was no torture and "no complicity in torture" by the British secret service." Our officers are as committed to the human rights values of liberal democracy as anybody else. They also have the responsibility of protecting the country against terrorism and these issues need to be understood in that context."
The Government's policy agreement said: "We will never condone the use of torture." Last month William Hague, the Foreign Secretary, said both the Tories and Liberal Democrats wanted an inquiry and the Government was working on what form it should take.