The scheme to save the royal yacht was said to have been negotiated by Gordon Brown, the Chancellor, to raise private finance for the refit. The vessel could then be hired back to the Government or the Queen for special occasions, such as exhibitions or receptions.
Tony Blair's ministers now face an embarrassing dilemma over Britannia. It is seen as an asset for Britain's export drive abroad and the lease- back scheme would enable the Government to use the vessel to fly the flag. But the MoD believes it would be better to build a new ship with private finance than to allow the old Britannia to run on for another generation.
The MoD will warn Mr Blair next month that he will risk breaching his election pledge, that not a penny of taxpayers' money will be spent on the ship, if he agrees to refit the royal yacht because its running costs - estimated at pounds 5m a year - could still fall on the MoD.
The Chancellor was reported to have stepped in to rescue the yacht after the MoD said that it would be decommissioned in December.
A Treasury spokesman said: "Private-sector proposals have been put to us and we are looking at them very closely. Private businesses see quite a big commercial opportunity in refitting Britannia; they see it as a way of securing export potential. We are keen to see a positive outcome."
But the MoD hit back yesterday, making it clear that it was highly unlikely to support the plan because refitting the vessel's out-dated engines would not answer the problem of its high running costs.
George Robertson, the Secretary of State for Defence, was said by senior Whitehall sources to be furious about a spate of reports at the weekend suggesting ministers were likely to reprieve the vessel in a lease-back arrangement for the Queen.
Ministers are heading for a showdown over the refit plan early next month with Peter Mandelson, the Minister Without Portfolio, who yesterday appeared to give support to the idea of allowing the royal yacht to continue in service for another 20 years.
Stressing that ministers had not explored all the options, he said: "The one that's reported today is the one that's receiving the greatest consideration. Ministers are working very energetically in trying to devise a way in which we can both keep the yacht and refurbish it properly so that it's good for the Royal Family and great for Britain too, but using private finance on a lease-back arrangement."
Mr Mandelson reaffirmed Tony Blair's election commitment not to spend taxpayers' money on the royal yacht. But the MoD is lined up to warn that refitting the vessel could lead to the running costs falling on the defence budget, which officials think would breach the election pledge.
The MoD is leading the review of the options for replacing Britannia, but will not allow it to be a burden on the defence budget any more. Defence ministers are adamant that they are not going to foot the bill for the running costs for the royal yacht, if it is reprieved.
"We don't know where this has come from, but it is simply not true," said a Whitehall source. "The Defence Secretary is not very happy with it. The question of the refit is being looked at as one of the options but it is only one of many.
"Refitting an old ship is never a very satisfactory exercise. You could end up with new engines, but a potentially leaking hull. There is talk of it having `hi-tech' equipment to cut down the running costs, but that is nonsense."
The MoD has been fighting to remove the yacht from its budget since the Falklands War when its defence role as an ambulance ship was exposed as a sham. The MoD wanted to scrap Britannia because of its heavy running costs. Its outdated engines require an oiler ship to travel with it, and it requires heavy over-manning by naval standards.
Under the lease-back scheme, it would still be crewed by the Royal Navy and the MoD argues that changing the engines will not reduce the manning costs.Reuse content