The UK Government is willing to pay compensation for the casualties and damage caused in Iraq when two British undercover soldiers were freed.
The incident saw violent clashes
During clashes on 19 September, the Army stormed a Basra police station.
The British consulate and a committee of Basra's council issued a statement announcing the offer and expressing regret at the casualties.
British opposition MPs voiced concern at the move, stressing support for the actions of UK troops.
Several Iraqis were killed or wounded when the police station walls were knocked down, and in a demonstration in Basra.
The joint statement said: "We regret the incidents that took place in Basra on 19 September 2005 at the Serious Crimes Unit.
"We also regret the casualties on both sides and the material damage to public facilities.
"The British government is prepared to pay valid claims for compensation for casualties and material damage in the well-established manner."
The local council in Basra had demanded compensation and an apology before it would agree to resume co-operation with British forces.
Joint patrols between the British Army and local police have since been curtailed.
The statement expressed full support for the "dignity of the institutions and people of the Governorate of Basra and the sovereignty of Iraq".
It said the British Government would deal with "those connected to the events" in accordance with the laws of the former Coalition Provisional Authority.
"This incident and other shooting incidents are subject to stringent official review.
"We hope to avoid a repetition of such incidents."
It said "frank dialogue" between UK and local government representatives was "key to cooperation in regard to the reconstruction of Basra and in making the necessary security arrangements for achieving the democratic process in Iraq".
The statement came three weeks after UK armoured vehicles destroyed the walls of Basra's police station, sparking violent protests.
Shadow foreign secretary Michael Ancram said that the Government appeared to be contradicting itself.
"In light of the strong support that John Reid offered yesterday for the actions taken by British troops in this very incident, it is quite extraordinary that the British Government should today make this apparently conflicting statement.
"We urgently need to know, what is the Government's true position?"
Liberal Democrat foreign affairs spokesman Sir Menzies Campbell said the announcement was "entirely political in nature".
"Compensation is being offered in an effort to ensure that co-operation by the civilian authorities is restored," he said.
"The senior British commander had no option but to take robust steps to rescue the two British soldiers whose lives were obviously at risk."