Mr Sarwar's lawyers later released a statement saying that Tariq Malik, the witness quoted in the News of the World story, had sworn an affidavit denying speaking to a newspaper.
The News of the World, which is already being sued by Mr Sarwar for pounds 750,000 over the original report, is standing by yesterday's story. Mr Malik, the third man in the Mr Sarwar's Mercedes when the MP allegedly handed over the money to Badar Islam, is quoted as saying that he saw Mr Sarwar pass pounds 5,000 to Mr Islam, an election rival.
Mr Malik, 46, the election agent of Mr Islam, allegedly told the newspaper: "The moment I saw the money I knew it was corrupt and illegal. I was stunned, frightened and very concerned about what was happening, and I knew it was wrong."
At a news conference in Glasgow, Chris Kelly, of the lawyers Hughes Dowdall, who are acting for Mr Sarwar, Britain's first Muslim MP, said last night: "Today the News of the World published further defamatory material concerning Mohammed Sarwar.
"The allegations made depended heavily on statements attributed to Mr Tariq Malik, the election agent of Badar Islam. Tariq Malik has today sworn an affidavit before a notary public in which he denies making to the News of the World any of the statements attributed to him by that newspaper."
Mr Kelly, accompanied by Mr Sarwar who remained silent throughout, continued: "In the affidavit, he also asserts that he was present as a witness at the meetings which took place between Mohammed Sarwar and Badar Islam and he affirms his belief in Sarwar's innocence of the allegations made against him."
Mr Sarwar said nothing during the news conference and would not answer questions from journalists. Mr Kelly did not produce a copy of the affidavit and did not elaborate on his statement.
Last night, the News of the World said: "We stand by everything that we have printed, and in particular today's leader column. We will see you in court, Mr Sarwar."
Last Friday, Mr Sarwar's lawyers launched a defamation action in the Court of Sessions against the publishers of the News of the World. This concerns the paper's original story on 18 May, in which it claimed that Mr Sarwar had paid an election rival - Mr Islam - pounds 5,000 to run a losing campaign. Mr Kelly said the allegations in today's edition of the NoW will be referred to in the action already launched.
Meanwhile, Gordon Guthrie, who ran Mr Sarwar's election campaign, became the first Labour figure publicly to condemn the MP. "Sarwar got into a car with a political opponent and a bag of money," he said. "That spells the end of any MP's career. He must go now."
Mr Guthrie claimed that when the scandal broke last week, Mr Sarwar said he would go if he was damaging Tony Blair's premiership. "He has to recognise that he is harming the party. He should keep his promise and quit," he said.Reuse content