The authorities in Oman say they have uncovered a network of spies working for the United Arab Emirates, according to the state news agency.
The alleged agents for the UAE are said to have spied on the Omani government and military.
The UAE government denies any knowledge of - or link with - such a network, according to its news agency.
The neighbouring countries are members of the Gulf Co-operation Council and normally enjoy good relations.
Government sources in Oman say the ring was discovered some months ago and that a number of Omani nationals have been arrested.
The spies may have been interested in the issue of the succession of Oman's Sultan Qaboos, according to a security official quoted by the Agence France-Presse news agency.
The sultan is 70 years old and does not have children.
But others suggested the alleged spy ring could be more related to regional politics.
"One possibility is that the UAE wants to know more about Iran-Oman relations because of Tehran and Muscat's long ties in security and military co-operation," Theodore Karasik, from the Institute for Near East and Gulf Military Analysis, told Reuters news agency.
Oman has close relations with Iran, partly because the two countries are joint gatekeepers of the Strait of Hormuz, the route for 40% of the world's oil tanker traffic.
But the sultanate also has strong military and diplomatic ties with the West.
The UAE is a staunch ally of the United States.
UAE authorities received the news with "shock and surprise" according to the Wam news agency.
"The UAE expresses its full willingness to co-operate with... Oman in any investigations that it carries out in full transparency to uncover (those) who try to mar relations between the two countries," said a foreign ministry statement.