SYDNEY (Reuters) - Australia on Thursday approved Qatar Airways buying a 25% stake in Virgin Australia from U.S. private equity firm Bain Capital, posing a challenge for national flag carrier Qantas that has long dominated Australian air routes.

Qatar Airways in October proposed to buy the minority stake for an undisclosed amount after the federal government in 2023 denied the Middle Eastern carrier's requests to fly additional services into Sydney, Melbourne, Brisbane and Perth.

Treasurer Jim Chalmers said the deal is expected to boost competition in the aviation sector and follows extensive talks by the government with industry, unions and other stakeholders.

"My decision aligns with the advice of the Foreign Investment Review Board that this proposal is consistent with the national interest," Chalmers said in a statement.

"I have approved this proposal subject to legally enforceable conditions that ensure Australian representation on Virgin's board and protection of its customer data."

Australia's treasurer has the power to cancel any foreign investments if it is deemed a risk to national security.

Virgin Australia CEO Jayne Hrdlicka said the deal will "support continued growth in line with the market domestically, improve our ability to compete for key segments of the market and add momentum to our margin ambitions".

Qantas on Thursday said its first-half profit surged 11% on the back of strong demand, and declared a special dividend for the first time in more than two decades.

"We always said that we welcome competition, and we always said that we weren't going to oppose the result. The announcement today was expected," Qantas CEO Vanessa Hudson said in an earnings call, when asked about the government's approval.

Qantas and its budget arm Jetstar together held about 65% of Australia's domestic market while Virgin, its biggest domestic competitor, has a 35% share, data from Australia's competition regulator showed.

Australia's competition watchdog last week backed a planned alliance between Virgin Australia and Qatar Airways, which could result in 28 new weekly return services between Doha and Australia's major cities.Virgin said its long-haul flights to Doha, expected to begin in June, will be operated using aircraft leased from Qatar Airways and will offer travellers flying to Europe, Africa and the Middle East more value and choice.

Qantas has a rival international flying partnership with Dubai-based Emirates. Virgin has a code-sharing agreement with Abu Dhabi-based Etihad which will expire on June 1.

Bain Capital continues to hold a majority stake in Virgin, for which it was targeting an A$1 billion listing before the plans were delayed.