BOSTON (Reuters) - A U.S. appeals court on Tuesday upheld a lower court's ruling that a prototype rifle design by Sig Sauer, which is believed to have made the gun used in last week's Orlando massacre, featured a built-in silencer that would make it subject to tougher federal restrictions on its sale and higher taxes.

Sig Sauer, which produced the semi-automatic rifle believed to be used in the deadliest mass shooting in modern U.S. history, had challenged a 2013 ruling by the Bureau of Alcohol, Tobacco, Firearms and Explosives, that the prototype not yet released for sale would be subject to a $200 transfer fee for each weapon sold due to the silencer.

The privately held company, based in Newington, New Hampshire, argued that the device on the end of the weapon was not intended to serve as a silencer but rather was a "muzzle brake," which can reduce recoil. Classifying the device as a silencer would subject the gun to stiffer federal requirements including stricter limits on record keeping and markings, which would result in there being "no market" for the gun, Sig Sauer said in court papers.

The decision comes at a time the U.S. firearms industry is lobbying to loosen restrictions on sales of silencers, contending that they can protect shooters' hearing.

The U.S. Appeals Court for the First Circuit in Boston rejected that argument on Tuesday.

"It is hard to believe that Congress intended to invite manufacturers to evade the (National Firearms Act)'s carefully constructed regulatory regime simply by asserting an intended use for a part that objective evidence in the record - such as a part's design features - indicates is not actually an intended one," Judge David Barron wrote.

The decision upheld an earlier finding by the U.S. District Court in New Hampshire.

It noted that the ATF had found that the gun involved in the case had "little or no practical use for a muzzle brake" due to its small size.

Sig Sauer has been growing rapidly in the United States, with plans to sell more silencers and ammunition while vying for a contract to supply several hundred thousand handguns to the U.S. military.

Orlando gunman Omar Mateen used a Sig Sauer MCX assault rifle to kill 49 people and wound 53 at the Pulse nightclub, according to a U.S. law enforcement official.

(Reporting by Scott Malone and Tim McLaughlin; Editing by Cynthia Osterman)