* Catalan stance sets region on collision course with Madrid
* Spanish government threatens direct rule
* High court jails heads of two separatist groups
* Tens of thousands demonstrate in Barcelona (Adds end of demonstrations)
BARCELONA, Oct 17 (Reuters) - Catalonia refused on Tuesday to bow to the Spanish government's demand that it renounce a symbolic declaration of independence, setting it on a political collision course with Madrid later this week.
Madrid has threatened to put Catalonia, which accounts for a fifth of Spain's economy, under direct central rule if its regional government does not abandon independence by Thursday.
But Catalonia's government rejected Prime Minister Mariano Rajoy's deadline.
"Giving in forms no part of this government's scenarios," Catalan government spokesman Jordi Turull said. "On Thursday, we won't give anything different than what we gave on Monday."
Spain's biggest political crisis in decades worsened on Monday night when Madrid's High Court jailed the heads of Catalonia's two main separatist groups pending an investigation for alleged sedition.
The Catalan government accused Madrid of taking "political prisoners" and tens of thousands of protesters gathered along Barcelona's Diagonal Avenue to call for their release.
People held up lighted candles, whistled and shouted "freedom" and "out with the occupying forces".
"There should not be political prisoners in a democratic country in the 21st century. This country is not democratic. I'm here to support democracy," said Alicia Cabreriza, a 26-year-old computer programmer from Barcelona.
The protests ended peacefully at around 2000 GMT.
Catalan leader Carles Puigdemont, in a tweet following the detentions, said: "Sadly, we have political prisoners again."
The phrase was an allusion to the military dictatorship under Francisco Franco, when Catalan culture and language were systematically suppressed. It carries an emotional resonance given fascism is still a living memory for many Spaniards.
Justice Minister Rafael Catala hit back, saying the jailing of the leaders of the separatist groups, the Catalan National Assembly and Omnium, was a judicial, not a political, decision.
"We can talk of politicians in prison but not political prisoners," he said. "These are not political prisoners because yesterday's prison ruling was due to a (suspected) crime."
The crisis has deepened divisions at the heart of Spain's young democracy, underlining the complex sense of nationhood in the euro zone's fourth largest economy.
In Madrid, unionists drape their homes in the national flag, while Barcelona apartment buildings are festooned with Catalan flags. Street protests of hundreds of thousands of people have been held on both sides of the divide, including in Catalonia.
"They've crossed a line," said Eulalia López, a 54-year-old office worker in Barcelona.
She said she and her colleagues would come out onto the streets if Madrid went ahead and took control of the region.
European capitals and financial markets have looked on with mounting alarm since Oct. 1, when Catalan authorities held a referendum on independence in defiance of a Spanish court ban.
ANC leader Jordi Sanchez and Omnium chief Jordi Cuixart are accused by prosecutors of helping to orchestrate pro-independence protests that last month trapped national police inside a Barcelona building and destroyed their vehicles.
That same incident also led to Catalonia's police chief, Josep Lluis Trapero, being investigated for sedition. He is accused of failing to order his force to rescue them from the building. He has not been detained but the High Court banned him from leaving Spain and seized his passport.
A string of companies, including two major lenders, have decided to move their headquarters outside Catalonia since the referendum.
Spanish police launched a violent crackdown in an effort to thwart the referendum, using rubber bullets and batons on voters in scenes that shocked Spain's European neighbours.
Catalan officials say 43 percent of voters still managed to cast ballots with 90 percent in favour of breaking away. Many unionists, however, obeyed Madrid and did not vote.
Spain's constitutional court, which had suspended the referendum, said on Tuesday the law passed by the Catalan parliament to hold the vote was void because it broke dispositions of Spain's 1978 constitution.
One of Catalonia's major foreign investors, Volkswagen, said on Tuesday that its Spanish division, Seat, had decided to delay announcing the name of its forthcoming model.
Seat, based in Martorell in Catalonia, had planned to announce the name of its 2018 sport-utility vehicle this month, about a year ahead of the 7-seat model's launch.
"With the entire Spanish media focused on politics at the moment, we have decided to find a better time," a Seat spokesman said, adding the division had also delayed the announcement of an innovation and digitisation agreement. He did not elaborate. (Additional reporting by Paul Day and Raquel Castillo; Writing by Mark Bendeich; Editing by Julien Toyer and Gareth Jones)