British intelligence paid large sums of money to an al-Qaeda cell in Libya in a doomed attempt to assassinate Colonel Gadaffi in 1996 and thwarted early attempts to bring Osama bin Laden to justice.

The latest claims of MI6 involvement with Libya's fearsome Islamic Fighting Group, which is connected to one of bin Laden's trusted lieutenants, will be embarrassing to the Government, which described similar claims by renegade MI5 officer David Shayler as 'pure fantasy'.

The allegations have emerged in the book Forbidden Truth , published in America by two French intelligence experts who reveal that the first Interpol arrest warrant for bin Laden was issued by Libya in March 1998.

According to journalist Guillaume Dasquié and Jean-Charles Brisard, an adviser to French President Jacques Chirac, British and US intelligence agencies buried the fact that the arrest warrant had come from Libya and played down the threat. Five months after the warrant was issued, al-Qaeda killed more than 200 people in the truck bombings of US embassies in Kenya and Tanzania.

The arrest warrant was issued in connection with the murder in March 1994 of two German anti-terrorism agents, Silvan and Vera Becker, who were in charge of missions in Africa. According to the book, the resistance of Western intelligence agencies to the Libyan concerns can be explained by MI6's involvement with the al-Qaeda coup plot.

The Libyan al-Qaeda cell included Anas al-Liby, who remains on the US government's most wanted list with a reward of $25 million for his capture. He is wanted for his involvement in the African embassy bombings. Al-Liby was with bin Laden in Sudan before the al-Qaeda leader returned to Afghanistan in 1996.

Astonishingly, despite suspicions that he was a high-level al-Qaeda operative, al-Liby was given political asylum in Britain and lived in Manchester until May of 2000 when he eluded a police raid on his house and fled abroad. The raid discovered a 180-page al-Qaeda 'manual for jihad' containing instructions for terrorist attacks.

The Observer has been restrained from printing details of the allegations during the course of the trial of David Shayler, who was last week sentenced to six months in prison for disclosing documents obtained during his time as an MI5 officer. He was not allowed to argue that he made the revelations in the public interest.

During his closing speech last week, Shayler repeated claims that he was gagged from talking about 'a crime so heinous' that he had no choice but to go to the press with his story. The 'crime' was the alleged MI6 involvement in the plot to assassinate Gadaffi, hatched in late 1995.

Shayler claims he was first briefed about the plot during formal meetings with colleagues from the foreign intelligence service MI6 when he was working on MI5's Libya desk in the mid-Nineties.

The Observer can today reveal that the MI6 officers involved in the alleged plot were Richard Bartlett, who has previously only been known under the codename PT16 and had overall responsibility for the operation; and David Watson, codename PT16B. As Shayler's opposite number in MI6, Watson was responsible for running a Libyan agent, 'Tunworth', who was was providing information from within the cell. According to Shayler, MI6 passed £100,000 to the al-Qaeda plotters.

The assassination attempt on Gadaffi was planned for early 1996 in the Libyan coastal city of Sirte. It is thought that an operation by the Islamic Fighting Group in the city was foiled in March 1996 and in the gun battle that followed several militants were killed. In 1998, the Libyans released TV footage of a 1996 grenade attack on Gadaffi that they claimed had been carried out by a British agent.

Shayler, who conducted his own defence in the trial, intended to call Bartlett and Watson as witnesses, but was prevented from doing so by the narrow focus of the court case.

During the Shayler trial, Home Secretary David Blunkett and Foreign Secretary Jack Straw signed Public Interest Immunity certificates to protect national security. Reporters were not able to report allegations about the Gadaffi plot during the course of the trial.

These restrictions have led to a row between the Attorney General and the so-called D-Notice Committee, which advises the press on national security issues.

The committee, officially known as the Defence, Press and Broadcasting Advisory Committee, has objected to demands by the prosecution to apply the Official Secrets Act retrospectively to cover information already pub lished or broadcast as a result of Shayler's disclosures. Members of the committee, who include senior national newspaper executives, are said to be horrified at the unprecedented attempt to censor the media during the trial.

Shayler claims Watson later boasted that there had been MI6 involvement in the Libyan operation. Shayler was also planning to call a witness to the conversation in which the MI6 man claimed British intelligence had been involved in the coup attempt.

According to Shayler, the woman, an Arabic translator at MI5, was also shocked by Watson's admission that money had been paid to the plotters.

Despite the James Bond myth, MI6 does not have a licence to kill and must gain direct authorisation from the Foreign Secretary for highly sensitive operations. Malcolm Rifkind, the Conservative Foreign Secretary at the time, has repeatedly said he gave no such authorisation.

It is believed Watson and Bartlett have been relocated and given new identities as a result of Shayler's revelations. MI6 is now said to be resigned to their names being made public and it is believed to have put further measures in place to ensure their safety.

A top-secret MI6 document leaked on the internet two years ago confirmed British intelligence knew of a plot in 1995, which involved five colonels, Libyan students and 'Libya veterans who served in Afghanistan'.

Ashur Shamis, a Libyan expert on radical Islam said: 'There was a rise in the activities of the Islamic Fighting Group from 1995, but many in Libya would be shocked if MI6 was involved.'