The UK's elections watchdog is to decide whether Labour has broken the law over cash for honours, and will advise police on whether a case should go to court.
The Electoral Commission will play a crucial role in the Scotland Yard inquiry and advise if there is enough evidence to prosecute Labour. Any file would then be presented to the Crown Prosecution Service.
Amid panic in Downing Street, police are understood to have widened their inquiry and to be examining several aspects of the Political Parties, Elections and Referendums Act (PPERA) which the party is believed to have flouted. Sources close to the inquiry believe the case for a prosecution is getting stronger.
The Independent on Sunday has learnt that police are "taking very seriously" evidence that several parts of the Act may have been breached. Scotland Yard is specifically looking at whether, if loans were made on non-commercial terms, Labour failed to disclose the "benefit", besides other possible breaches.
The Electoral Commission has already met the police on several occasions to advise on the law over loans and donations to political parties. The commission is expected to be given the complete file of secret police evidence in late January and asked whether it thinks the case is strong enough to prosecute.
Experts say the allegation that honours were promised in return for cash is bolstered by Labour's apparent attempts to cover up the receipt of loans from millionaire donors who were proposed for honours by Tony Blair.
Labour failed to disclose the loans in its 2004 accounts, and kept its ruling body, the National Executive Committee, in the dark about them. The party's treasurer, Jack Dromey, and most of the Cabinet were also not informed in what is being seen as evidence of a deliberate attempt to keep the loans quiet. Sir Gulam Noon, who was proposed for a peerage by Mr Blair, was also told by Lord Levy to remove a reference to the loan in his nomination form to the House of Lords because it did not technically have to be included.
As leader of the Labour Party, Mr Blair could be culpable under the law, along with Matt Carter, the former general secretary and registered treasurer of the party. Penalties under the Act include prison terms of up to a year. Mr Blair's police interview focused on his decision to nominate four millionaire donors to the Labour Party for honours. The police wanted to know why he thought the millionaires, who also lent money to Labour, were suitable for positions in the Lords.
Under the 1925 Honours (Prevention of Abuses) Act, the police are investigating allegations that millionaire Labour donors and lenders received peerages in return for huge donations and loans to the Labour Party in the months before.
Labour has begun to pay back the loans and last week repaid several hundred thousand pounds to Sir Christopher Evans, the biotechnology millionaire who lent Labour £1m and was subsequently arrested in the cash-for-honours affair. The repayment, the first in a number of instalments, included interest accumulated at 2 per cent above the Bank of England base rate.
Downing Street officials including Ruth Turner, John McTernan, director of political operations, and Jonathan Powell, Mr Blair's chief of staff, are expected to be reinterviewed by the police about gaps in evidence.
The police are considering whether the loans were given on commercial terms. If not, Labour should have publicly disclosed the "benefit" of receiving loans on favourable financial terms. Other political parties, including the Liberal Democrats, have disclosed the financial benefits of receiving loans on favourable terms.
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