Tories face £5m black hole after launch of inquiry into Ashcroft

David Cameron faces embarrassment and the prospect of a near £5m black hole after the electoral watchdog began a formal investigation into the Tories' biggest donor.

The Electoral Commission has launched an inquiry into donations made by a company controlled by Lord Ashcroft, the party's deputy chairman and key strategist. The move follows complaints that £4.7m of gifts to the Conservatives from Lord Ashcroft's company, Bearwood Corporate Services, could have breached electoral laws.

The party could be ordered to pay back the money if it is judged to have wrongly accepted it.

Bearwood's registered address is in Southampton but it is reported to have received its income from companies based in the central American country Belize, where Lord Ashcroft still has extensive business interests.

Political parties are only allowed to receive donations from companies that are registered in Britain and do business in this country.

The Conservative Party insisted yesterday that the donations were "legal and permissible". "We are confident these contributions to the party are entirely acceptable," Liam Fox, the shadow Defence Secretary, said.

But the Labour MP John Mann, who has been pressing for an inquiry, said: "Tax exiles should not be allowed to give money to influence the results in British elections. "I am very pleased this investigation has been launched. It's a significant first step to getting to the bottom of what is going on."

Lord Ashcroft has become a powerful figure at Conservative headquarters, taking charge of the party's drive to win crucial marginal seats at the next election.

He was ennobled in 2000 on condition that he moved his tax affairs from Belize to Britain and he served as the party's treasurer between 2002 and 2005. He has repeatedly refused to comment on his tax status or whether he is resident in Britain, although Mr Cameron has said he is honouring the promises he made in 2000.

The Electoral Commission held a preliminary inquiry into the donations last year and has now moved on to a full investigation. It is likely to concentrate on whether Bearwood is carrying on business on Britain.

A spokesman confirmed: "We have begun a formal investigation into whether there has been any failure to comply with the Political Parties, Elections and Referendums Act in connection with a number of donations made to the Conservative Party by Bearwood Corporate Services."

The former Labour minister Denis MacShane said that Mr Cameron should stop accepting the peer's money until the investigation by the Electoral Commission had been completed. "It is now time David Cameron stopped ducking the issue of Lord Ashcroft's relationship with the Tory party and sorted out the shadowy funding arrangements that have become systematic under his leadership," he said.

Michael Spencer, the Tory treasurer, confirmed last month that Lord Ashcroft was the party's biggest benefactor in 2008 but emphasised that the funds accounted for only 6 per cent of the party's income.

"Strictly speaking, it's not Lord Ashcroft who gives us the money, it's the corporate vehicle, Bearwood Corporate Services which is completely compliant," he said.

A Tory spokesman said yesterday: "The Conservative Party compliance unit applies two strict tests to all company donations in accordance with Electoral Commission guidance.

"They are: is the company UK-registered and is the company trading? The donations from Bearwood Corporate Services Ltd met those tests."