The donation from a firm owned by a Majorca-based businessman is being scrutinised by the Electoral Commission to see if it broke the rules banning gifts from abroad.
The gift, made in several parts, is the largest donation ever given to the Liberal Democrats. The funds paid for almost half of the party leader Charles Kennedy's campaign in the general election and enabled him to spend far more on advertising than ever before.
Last night the Liberal Democrats insisted that the donation from 5th Avenue Associates, a UK-based company owned by Michael Brown, did not break the rules on the funding of political parties.
Mr Kennedy has met the little-known Scottish businessman several times and was flown by him in his plane to the Liberal Democrat's spring conference in Harrogate before the general election.
The donation was kept strictly secret by the Liberal Democrats during the campaign and, at the time, the party denied it had received the cash.
Reg Clark, the party's former treasurer, resigned before the election following a terrible row, which is reported to have involved the donation.
The Liberal Democrats have been in correspondence with the Electoral Commssion over the matter and expressed confidence last night they had not broken the rules.
"We believe we have acted in good faith and properly in relation to all donations received by the Liberal Democrats. And that all donations we have received are legitimate and from individuals entitled to donate to British political parties or from companies based and trading in the UK," a spokesman for the party said.
If the watchdog were to conclude that the Liberal Democrats had broken the rules on funding it would be forced to return the donated money to Mr Brown, sparking a serious financial crisis which could force the party to remortgage its valuable Westminster headquarters.
The electoral commission is expected to examine where the donated cash came from and whether it originated from the UK or a parent company based in Switzerland. It is also expected to examine when Fifth Avenue Associates company registered in the United Kingdom.
A statement from the Electoral Commission said: "We would not regard as lawful a donation made by a foreign company which set up a firm in Britain simply for the purpose of giving money to a party."
Michael Brown, a publicity shy businessman, is not a member of the Liberal Democrats and is not well known in London. He is said to have made the donation because he wanted to even up the contest at the general election between the Liberal Democrats and Labour and the Conservatives, who were both far wealthier parties.
He has met Mr Kennedy and senior Liberal Democrat figures and is said to have been impressed by the leader.
His United Kingdom-based company does have staff and pays tax on their salaries. The company is believed to have been established in Britain last year and to be VAT registered.
Lord Razzall, the party's campaign chairman, said: "When someone comes to you and offers a large sum of money it is inevitable that a lot of the checks you make are going to be based on what that individual has told you.
"We also got independent verification that the firm was trading in the UK and I am sure the electoral commission will come to the same conclusion."
- More about:
- Liberal Democrat Party