Britain could face a damaging multibillion-pound trade war with China and see the roll-out of economically vital 4G mobile internet services derailed if an intelligence report, due to land on David Cameron's desk within the next two weeks, finds that the UK operations of the Chinese communications giant Huawei represents a threat to the UK's cyber-security.

Downing Street, according to intelligence sources, is prepared to face a costly trade backlash by Beijing if it opts to blacklist the multinational over allegations that the company has links to the Chinese army and concerns that its equipment could be used for cyber-espionage by the Chinese government. Huawei, though not a high-profile consumer brand in the UK, controls a quarter of the EU's telecom-equipment market, winning over half of all the contracts for 4G infrastructure technology awarded throughout Europe. The Chinese multinational is also supplying the 4G technology for EE, the company that controls Orange and T-Mobile, and has signed similar deals with O2 and 3UK.

There is also a major contract with BT to update its fibre-optic broadband network, and Huawei's other UK clients include Vodafone, BSkyB and Virgin Media. Huawei products are therefore likely to be inside most British households.

Concerns over the potential for state cyber-espionage involving Huawei has recently seen the US House of Representatives' intelligence committee recommend that the Shenzhen-based company be restricted from operating on US soil. In Australia it has been excluded from bidding to supply the lucrative national fibre network. A similar move is under consideration by Canada.

Huawei was not named specifically in a telecoms report published by the EU earlier this year. However, the dominance of Chinese firms in the European telecoms market was described as a "major security risk". Brussels also believes that the Chinese government may be covertly subsidising its leading telecoms firms, allowing them to undercut, and ultimately put out of business, their European rivals.

A leading industry figure who spoke to The Independent on Sunday, on condition of anonymity, said that if the Government opted to blacklist Huawei, "the costs would be considerable to mobile companies and broadband providers. The infrastructure would be hit if companies couldn't use Huawei technicians as it is in constant need of repairs and upgrades. It would be a threat to digital Britain."

Although the UK's signals intelligence centre at GCHQ in Cheltenham has a technical laboratory which has been vetting and monitoring new Huawei equipment for over two years, Downing Street earlier this year came to the view that growing concern in the US and EU over dominant Chinese telecommunications firms merited an accelerated security evaluation by the UK's intelligence services.

The Intelligence and Security Committee set up the review in the autumn. The Prime Minister is understood to have been informed of its draft findings, ahead of the final report due before Christmas.

Mr Cameron's pledge in late 2010 to double UK trade to China to £62bn by 2015 means the report's findings could be a game-changer for Britain's trade ambitions with the new Chinese leader, Xi Jinping, if Huawei is blacklisted. But if Downing Street were to dismiss publicly US, Canadian and EU concerns as unsubstantiated conspiracy theory, Mr Cameron would leave himself open to the charge of keeping Beijing happy at the expense of UK cyber-security.

A senior source close to the National Security Council, the cabinet committee with responsibility for overseeing security and intelligence co-ordination, said that if malware or spyware has been found in any of Huawei's UK operations "then the Government will blacklist it". The source said the situation remained complex simply because new advanced technologies often had dual uses.

A compromise position said to be under consideration by the Government would limit Huawei's involvement in UK military or Whitehall contracts Ω the firm supplies defence systems such as submarine wiring Ω but leave it free to compete in other sectors. But even limited action by the UK against Huawei would be seen by Beijing as damaging one of its leading technology firms, with retaliation in the form of trade sanctions likely to follow.

Dr Richard Clayton, of the University of Cambridge's Computer Laboratory, said international focus on China's increasing dominance of telecoms infrastructure centred around "added functions" that could be built covertly into large-scale systems, potentially giving one country the ability to shut down another's communications network.

He told The IoS that those who are concerned about the issue fear that "in times of tension, secret back doors in telephone exchanges or internet routers will allow the Chinese to disable our communications systems or wiretap our leaders' conversations."

The US House of Representatives' report was critical of how Chinese firms, including Huawei, co-operated with its investigation. It said Chinese companies believed any internal information was a "state secret" that could only be made public if approved by the Chinese government. This, the intelligence report concluded, "only heightens concerns about Chinese government control". It admitted that the lack of evidence limited any clear-cut conclusions. However, the report insisted that Chinese telecommunications "provide an opportunity for the Chinese government to tamper with the United States telecommunications supply chain".

On the technological "vulnerabilities" of particular Huawei products or components, the report said it did not attempt a full evaluation, but nevertheless said it "took seriously recent allegations of back doors, or other unexpected elements" in key telecoms products.

Huawei denies any link between its international business operations and state-sponsored cyber-spying. Its official response to the US report said the allegations were "a monstrous, market-distorting, trade-distorting policy precedent that could be used in other markets against American companies".

The Chinese firm believes criticism contained in the US report is merely thinly disguised protectionism. A Chinese minister recently accused the United States of returning to a "Cold War mentality".

The company was asked this weekend for a response to the prospect of the UK blacklisting its products, but, by press time, it had not responded.

Huawei: A runaway business success

Ren Zhengfei, a former technologist in the People's Liberation Army (PLA), founded Huawei in 1988. It won its first international contract in 1997, and is now the world's largest telecoms manufacturer, with profits close to $4bn and operations in 140 countries. Two years ago it made it into the Global Fortune 500 list, with annual sales estimated at $21.8bn.

Huawei – which means "action for China" – classifies itself as a "collective", not a private firm. But a recent US report alleged that it has close links to the Chinese military, with documentation, said to be from former employees, linking it to an "elite cyber-warfare unit with the PLA". Huawei dismisses the claim as fantasy.

There are also allegations, under investigation, that Huawei's operations in India developed telecoms equipment for the Taliban in Afghanistan.

China is crucial to the Government's growth plans. Huawei is part of that plan; UK investment at the end of last year passed £150m and is set to accelerate with its lead role in the 4G internet network. A September meeting between Ren and the PM – two months after two US researchers said they had uncovered "critical vulnerabilities" in Huawei routers – was more concerned about Huawei's expansion in the UK, new jobs, and its plan to double its European workforce to 1,000.