It's discrimination. No bones about it.
Sorry to sound preachy, but the attitude towards people who smoke in the UK is repulsive. I don't tell someone with b.o to FO now do I?
For an employer BO is just as much an issue in a public or office environment as smoking.
The trouble is I think it's only recently smokers have begun to realise just how much many (most?) non-smokers loathe the smell of the stuff. And as smoking is phased out in more areas of life, that means more of us notice the smell more when we are exposed to it. So as a health measure it's working... smoking is locked into a feedback loop now which means it will become more and more socially unacceptable.
Anyway, the OP is treading on dangerous ground. Employment law is very hard work (for understandable but sometimes counter-productive reasons) and the only way I can see around this situation is to keep your mouth firmly shut about smoking, just in case. Either get used to the smell for the sake of the business, or choose someone else. This stage of the employment process is the only bit you have full control over... unless you put your foot in it and get sued for discriminatory employment practices, obviously.
All in all it's no wonder so many small businesses go under.

Personally I think an employer should be able to pretty much dictate exactly who they employ for whatever reason they feel like without fear of consequences. While that could lead to nastiness (whites only, no women likely to have children, etc.) businesses are not charities, and there are plenty of laws now to protect workers once they're employed. It's not like the bad old days when unions were all that stood between you and being treated like a slave.
It is a hideously complicated area though. And while we mess about with stuff like this, Asia's low wage, low protection economies march ahead. If we're to compete we have to find a sensible balance somewhere to encourage businesses and cut the red tape. I'd hate to be the one trying to do it though!
Andrew McP