Iran military denounces Saudi "killing" in Yemen

* Signs of Tehran-Riyadh tension over fighting in Yemen

* Iran parliament suspends tax cooperation deal with Sanaa

TEHRAN, Nov 17 (Reuters) - A senior Iranian military official on Tuesday accused Saudi Arabia of killing Shi'ite Muslims in Yemen and denounced it as the onset of "Wahhabi state terrorism," the official IRNA news agency reported.

In another sign of increased regional tension over fighting in northern Yemen, Iran's parliament shelved a bill on tax cooperation with Sanaa in protest at its treatment of Yemen's minority Shi'ites, Iranian state broadcaster IRIB said.

Riyadh launched an assault on neighbouring Yemen's Houthi rebels about two weeks ago after they staged a cross-border incursion that killed two Saudi border guards.

The rebels of the Zaidi Shi'ite sect have accused Saudi Arabia, whose Wahhabi brand of Islam regards Shi'ites as heretics, of backing the Yemen government, while the government sees Iran's hand behind the rebels.

Saudi Arabia, the world's top oil producer and a U.S. ally which sees itself as the guardian of Sunni Islam, has often been at odds with Shi'ite Iran.

"The killing of Yemeni Shi'ites by Saudi Arabia is the onset of Wahhabi state terrorism, which is very dangerous for Islam and the region," said Major General Hassan Firouzabadi, chief of staff of Iran's armed forces, IRNA reported.

He warned that the situation could spread and sooner or later "engulf all Muslims, everywhere."

Saudi clerics have accused the rebels in Yemen of working with Iran to try to spread Shi'ism in Sunni Islam's heartland.

Yemen said last month it had seized a vessel carrying weapons destined for the rebels and detained its Iranian crew at a port in Haja province bordering the area of conflict.

Yemeni President Ali Abdullah Saleh has said Iranian religious figures provide funding for the rebels, and officials have also accused Iranian media of backing them.

Iran has denied the allegations and called on Yemen's government to end the fighting through negotiations.

Yemen, which is mostly Sunni Muslim, is battling al Qaeda militants and secessionist discontent in the south, as well as the rebellion in the north that borders Saudi Arabia.

Both the Yemen government and the rebels have said that the conflict between them is not sectarian.

Yemen stepped up a military campaign against Houthi rebels in August. Fighting between Yemeni troops and Houthis, who belong to Yemen's Zaidi Shi'ite minority and say they suffer religious, economic and social marginalisation and neglect, has flared on and off since 2004 in the northern province of Saada. (Reporting by Hashem Kalantari; writing by Fredrik Dahl; editing by Samia Nakhoul )