(Adds details, background, context)

By Costas Pitas

LONDON, March 20 (Reuters) - The gravest accusation in an inquiry into abuse of Iraqis by British troops was effectively dropped on Thursday when lawyers for relatives of dead Iraqis said there was insufficient evidence they had been unlawfully killed by soldiers.

The inquiry, which has cost 22.2 million pounds ($37 million) so far, has been set up to investigate allegations by Iraqis that soldiers killed up to 20 men at an army camp in 2004, and mistreated up to nine detainees.

But lawyers representing the Iraqi relatives of those allegedly mistreated or killed said there was not enough evidence to establish that Iraqi civilians were unlawfully killed in the custody of British troops.

"It is accepted that on the material which has been disclosed to date there is insufficient evidence to support a finding of unlawful killing in Camp Abu Naji," said John Dickinson, a lawyer at Public Interest Lawyers (PIL).

The inquiry will hear testimony from a further witness and closing submissions in April. Chairman Thayne Forbes will make the final ruling on whether unlawful killing took place and decide on other allegations of mistreatment and violence.

British authorities have said the 20 men died on the battlefield, while relatives and local residents allege they were captured alive and later executed and mutilated at the military camp.

British soldiers deny any mistreatment.

The inquiry is one element of a legacy of allegations dating back to the Iraq war that haunt Britain almost three years after the final British troops left in 2011.

A spokeswoman for the Ministry of Defence said it had long argued there was no credible evidence for the allegations and was pleased with Thursday's comments by the lawyers.

Over 42 weeks since March 2013, the inquiry has heard from hundreds of witnesses, including 55 Iraqis speaking via video link from abroad.

It has previously heard graphic evidence including that a British soldier saw his platoon sergeant fire into the twitching bodies of two Iraqi gunmen lying on the ground during a battle in 2004.

A final report is expected in November. (Reporting by Costas Pitas, editing by Kate Holton and Guy Faulconbridge)

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