The New Zealand military vehemently denies the accusations, which were first made in a book "Hit and Run" published last year.

The book alleged an elite SAS squad staged the raid as a "revenge attack" after a New Zealand soldier was killed, but faulty intelligence meant it targeted villagers rather than insurgents.

It also claimed the military covered up the raid's failure, falsely saying nine insurgents had died when it knew otherwise.

The centre-left Labour Party called for an independent inquiry while in opposition and Attorney-General David Parker reviewed the case following last year's election win.

Parker on Wednesday appointed former prime minister Geoffrey Palmer and Supreme Court judge Terence Arnold to head the probe.

"Bearing in mind the need for the public to have confidence in the NZDF, I have decided in the public interest that an inquiry is warranted," he said.

Parker said he had seen video of the raid suggesting there were "armed individuals" in the village but the footage was not conclusive, hence the need for the inquiry.

It will examine the conduct of troops during the raid, whether those killed were insurgents or civilians and the accuracy of military briefings given to the public and the government.

It is expected to take up to a year.

The New Zealand Defence Force chief, Lieutenant General Tim Keating, said he stood by earlier statements about the raid.

"At all times throughout this operation our NZSAS acted professionally and conducted themselves to the high standards expected of our special forces," he said.

New Zealand sent a reconstruction team and a small special forces contingent to join the NATO-led operation in Afghanistan in 2003.

In early August 2010, Lieutenant Tim O'Donnell became the first of New Zealand's 10 military deaths in Afghanistan when his patrol was hit by a roadside bomb.

The SAS raid in the northern province of Baghlan, carried out with US helicopter support, took place about two weeks later on August 22.

In the following days Mohammad Ismail, a district chief for Tala Wa Barfak, where the incident occurred, told AFP that eight people died in the raid, all civilians.

The New Zealand military initially kept silent about its involvement, then said nine insurgents were killed and no civilians harmed.

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