Shafiq ur Rehman, 28, who is fighting to overturn an expulsion order made by the Home Secretary, Jack Straw, on the recommendation of MI5, turned down the approach from a Security Service officer in 1997.
Mr Rehman, from Oldham, Greater Manchester, is accused of heading the British arm of a front organisation for a rebel Mujahideen group fighting in the disputed north Indian territory of Kashmir- the scene of bloody clashes between Indians and Pakistan-backed fighters in recent weeks.
He has allegedly raised thousands of pounds for the Lashkar Tayyaba (LT) group involved in the insurrection close to the Pakistani border and arranged for young British Muslims to be sent to Jihad or Holy War training camps run by LT near the Pakistani city of Lahore.
Lawyers for Mr Rehman, who came to Britain from his home near Lahore in 1993 and has two children, argued that his decision not to help MI5 was now being used against him. Sibghat Kadri QC, said: "He has been punished for his refusal not to become an informer. If is for that reason, among others, that he is being deported."
The landmark case is believed to be the first heard by the newly established Special Immigration Appeals Commission, set up last year to adjudicate on deportation orders made by the Home Office on national security grounds.
A High Court Judge, Justice Sir Humphrey Potts, who sat on the trial of the war criminal Anthony Sawoniuk earlier this year, is hearing the four-day appeal at the headquarters of the Immigration Appellate Authority in King's Cross, London.
Mr Rehman's lawyers claim he works for a political and cultural group known as MDI, or the Centre for Invitation to the Divine Teaching, which raises funds for schools and universities in the Punjab area. Although acknowledging MDI has links with the Mujahideen force LT, Mr Rehman claims he was not involved in securing cash for terrorist purposes. And while he is not accused of conducting terror activities in Britain, MI6 says his work could still pose a threat to national security.
A Home Office submission to the hearing said: "Mr Rehman has been partly responsible for an increase in the number of Muslims in the UK who have undergone some form of militant training, including indoctrination into extreme beliefs and at least some basic weapons handling.
"The Security Service is also concerned that the presence of returned Jihad trainees in the UK may encourage the radicalisation of the British Muslim community.
"Mr Rehman's activities in the UK are intended to further the cause of a terrorist organisation abroad."
Mr Kadri accused the head of the security service branch monitoring terror activity in the Indian sub-continent, identified only as Witness J, of enforcing an unfair policy towards radical Muslim groups in Britain.
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