By Allison Lampert and Ana Mano

MONTREAL/SAO PAULO (Reuters) - Canada insisted on Friday that it plays by international trade rules after Brazil warned it may challenge government funding to planemaker Bombardier Inc, a move that would revive a two-decade-old dispute between the two countries.

The Montreal-based company is locked in competition with Brazil's Embraer for narrowbody jet sales. The South American country has said favorable government financing gives Bombardier an unfair advantage in sales campaigns.

Brazilian Foreign Minister Jose Serra told Reuters on Thursday it could move against Canada at the World Trade Organization (WTO) over $1 billion in funding that Bombardier received from the Canadian province of Quebec.

Canadian Prime Minister Justin Trudeau brushed off the suggestion, telling reporters "there is no country in the world that doesn’t heavily subsidize its aerospace sector."

Brazil and Canada have locked horns repeatedly at the WTO over the past 20 years regarding state support for Embraer and Bombardier, the world's biggest commercial planemakers after powerhouses Boeing Co and Airbus Group..

Ottawa is also in discussions with Bombardier on matching Quebec's investment in the CSeries program, which ran years late and billions of dollars over budget. Quebec and Bombardier want the federal government to match the province's CSeries investment, but negotiations have dragged on, with sources close to the talks saying Trudeau's Liberal government wants changes to the plane and train maker's dual-class share structure.

Embraer's concerns about the funding boiled over in April when Bombardier won a deal to provide 75 aircraft for U.S. carrier Delta Air Lines Inc for the CSeries narrowbody jet, beating Embraer's E190 family of jets with what many industry watchers saw as an aggressive bid.

The Brazilian company said at the time it was no longer "competing with a private enterprise."

A Bombardier executive said on Friday that Embraer was likely worried about the competition from the CSeries, which made its first scheduled commercial flight on Friday with Swiss Airlines.

"They have seen our airplane go through the certification process and now enter into service. There is certainly a lot more competition and they are probably concerned about what the CSeries means for their business," said Ross Mitchell, a vice president of commercial operations for Bombardier.

Speaking in Calgary, Trudeau echoed the sentiment, saying competitors were "rightly worried" about the CSeries jet.

An Embraer spokesman said the company has asked the Brazilian government to monitor any funding the federal government gives Bombardier.

"Embraer is capable of competing against any companies, but not against the government of Canada," he said.

Quebec's equity stake in the CSeries, first agreed to in 2015, is more difficult to challenge than a straight export subsidy arrangement, said trade lawyer Mark Warner at MAAW Law in Toronto.

However, Embraer could raise legitimate questions over Delta buying CSeries jets at heavily discounted prices, especially given that the Canadian company had not signed a single deal for the planes in more than a year before ones with Delta and Air Canada in 2016.

At the very least, Brazil's threat of a challenge could scare away potential customers who see risks to future funding for Bombardier from Canadian governments.

“Most people don’t like messy situations,” Warner said.

(Additional reporting by David Ljunggren in Ottawa and Nia Williams in Calgary; Editing by Jeffrey Hodgson and Jonathan Oatis)