NEW YORK, June 21 (Reuters) - A New York state appeals court on Tuesday lifted a temporary restraining order that prohibited the state from collecting taxes on cigarettes sold to non-tribal members on Indian reservations.

The ruling, by the Appellate Division, Fourth Department, gives the state permission to start collecting $4.35 on each pack of cigarettes, while the Seneca Nation of Indians continues to challenge state regulations in court.

The tribe contends the state Department of Taxation and Finance failed to comply with the State Administrative Procedure Act before amending New York's tax law. The law requires tribal retailers to pay the tax to wholesalers when purchasing inventory and recoup the money by adding it to the retail price. Tribal members would have access to a set number of tax-free cartons.

In a one-page order, the appellate justices denied the nation's request for a preliminary injunction and vacated a temporary restraining order that has been in place since June 9. The appeal is still pending.

Seneca Nation President Robert Odawi Porter said the Nation will seek leave to appeal the latest decision to the Court of Appeals, New York's highest court. In the interim, he said, the tribe will focus on selling native brands manufactured in their territories, instead of national brands such as Marlboro and Camel.

"While the state may be able to embargo through taxation premium brands from entering our territory, it cannot tax the brands made in our territory or any of the six nations," Porter said. "We will never stop fighting the state's predatory actions."

"CRIPPLING EFFECT"

The law was slated to take effect on Sept. 1, 2010, but was stayed when several Indian tribes filed suit in federal court to preclude enforcement. After the U.S. Court of Appeals for the Second Circuit lifted the stay, the Seneca Nation turned to state court.

The New York Association of Convenience Stores, which filed a brief in support of the tax, applauded the ruling.

"If one retailer has to collect taxes on cigarettes, then their competitors should have to do the same," said Jim Calvin, president of the association.

"It has had a crippling effect on convenience stores in proximity to tribal enterprises, and some have had to go out of business completely," Calvin said.

The state's Attorney General said the state stands to collect about $500,000 a day in additional revenue. The state has argued that the tax also promotes public health.

The case is Seneca Nation of Indians v. New York State et al, New York Appellate Division, No. 11-01193.

For Seneca Nation: Carol Heckman of Harter Secrest & Emery.

For New York State et al: Andrew Bing and Darren Longo of the New York State Attorney General's Office.

(Reporting by Jennifer Golson)