Prosecutors with Spain's High Court will investigate illegal activity including money laundering and tobacco smuggling in Gibraltar, Spanish media reported on Monday.
The decision to investigate comes in the wake of a report from the European Commission's anti-fraud office, Olaf, in which the agency said there was "reason to believe" such illegal activity had taken place in the UK-held territory.
"Olaf can confirm that it has completed its investigation into the increase in cigarette smuggling in the south of Spain," the agency's press office told The Local.
"This investigation was initiated in August 2013 following a complaint concerning increased smuggling of cigarettes across the frontier between Gibraltar and Spain in the period 2009-2013," a spokesperson said.
"The concerns include indications of the involvement of organised crime," that spokesperson added.
The report has not been made public but lends weight to assertions from Spain that Gibraltar is a smuggling hotspot and a tax haven for criminals.
It could also help Spain justify the lengthy queues at the Spain–Gibraltar border, a situation which has caused friction between Spain and Britain in the last 12 months, Spain's El País newspaper.
Relations between London and Madrid became particularly strained last year after Gibraltar dropped 70 concrete blocks into the sea in July, in what its government said was an attempt to create an artificial reef.
The move had the effect of also blocking Spanish fishing boats from operating close to the airport runway, and Madrid responded by introducing stringent border checks.
Spanish media outlets on Monday reported that tobacco imports into Gibraltar tripled from 2006 to 2011. In 2012 alone. 110 million packets of cigarettes were imported.
With a population of some 30,000, this would mean "every Gibraltarian, including breastfeeding babies , would have to be smoking nine packets a day," one Spanish government source was cited as saying by Spain's El País newspaper.
Tobacco prices in Gibraltar are far cheaper in Gibraltar — around €25 to €27 for a carton — than in Spain, where the cost ranges from €40 to €44.
Spanish authorities say much of the tobacco imported into Gibraltar is smuggled across the border into Spain, meaning losses to Spain's tax coffers of around €1.2 billion, while Gibraltar argues tourists buy much of the imported tobacco.
In the first five months of 2014, Spanish police stopped 2,793 people crossing the border with more than their permitted tobacco allowance. A total of 295,698 were seized in the same period, according to Spanish daily El Mundo.
Gibraltar has admitted the territory sees some tobacco but argues the problem of is far greater in Spanish ports.
Some 19 percent of Spain's gross domestic product comes from tobacco sales.
The EU has now urged both Spanish and UK authorities to take legal action to tackle the problem.
"The OLAF final case report and recommendations to initiate judicial proceedings related to the findings of the report have been sent to the Spanish General State Prosecutor and to the Gibraltar Attorney General via the UK Permanent Representation in Brussels," the agency told The Local.
"As OLAF can carry out only administrative investigations, it is for those authorities to decide what further actions may be necessary."