Officials in Tehran have demanded his return so that he can face trial in Iran for the murder of two hostages during the siege in 1980, which would lead to an inevitable death sentence.

But the Daily Mail has learned that preparations are under way for 50-year-old Nejad, who is Iranian, to spend the rest of his life in Britain.

Iran has warned bluntly that the already strained relations between London and Tehran will suffer further if he is not sent back.

Whitehall sources accept, however, that there is no realistic prospect of removing Nejad as human rights legislation prevents Britain sending anybody back to a country where they are likely to be executed.

Iranian foreign ministry spokesman Mohammad-Ali Hosseini said: "Freedom of the terrorist is not at all justified and is a sign of the UK's double-standard approaches towards the issue of terrorism."

The release will be hugely sensitive and officials will seek to limit the political damage by awarding Nejad a new restricted type of asylum status.

The measure, due to become law later this year, is designed for those who have committed serious crimes but cannot be removed. It will allow Nejad to remain, but he will be banned from receiving all state handouts such as housing and benefits.

He and five other terrorists forced their way into the Iranian Embassy in Prince's Gate, Kensington, in April 1980, taking 26 hostages.

The gang were demanding independence for a part of Iran and the release of comrades.

Prime Minister Margaret Thatcher ordered in the SAS after the terrorists murdered a hostage six days into the siege and threw his body on to the street.

A second hostage was killed by the terrorists as the SAS abseiled from the roof of the building and smashed through the windows in a spectacular operation witnessed live on TV around the world.

Nejad was sentenced at the Old Bailey in 1981 to life imprisonment for conspiracy to murder, false imprisonment, possession of a firearm and two charges of manslaughter.