Libya offered a "huge donation" to cash strapped Labour in a bid to overcome its isolation as a pariah state.

Tripoli also offered to broker arms deals worth up to £6 billion.

Both approaches were made to Labour peer and whip, Matthew Evans, in 1998 and were instantly rejected.

"The proposal was absolutely ridiculous," a Labour source told the Guardian.

"Even if foreign donations were not outlawed we never would have considered it.

"The Libyans want to rub shoulders with British politicians and seemed to think this was a way."

Meanwhile Labour is poised to agree a funding deal with trade unions worth £40 million over five years.

Under the proposal, trade unions will no longer make annual contributions and instead guarantee funding over the maximum five-year lifetime of a parliament.

Following the next general election, they will underwrite a third of Labour's running costs, now £21 million a year, for the following five years.

"Labour is the only show in town and we want to show our commitment," one union leader told today's Telegraph.

However, the FT reports that some Labour donors may cease their financial contributions in protest against a possible war with Iraq.