Loach showed off his new film, starring footballer Eric Cantona, in Cannes
The Edinburgh International Film Festival has returned a £300 grant to the Israeli government after Ken Loach called for the event to be boycotted.
The money was to be used to fund an Israeli film maker's travel expenses to Scotland to exhibit her short film.
Loach said the grant was "unacceptable" and urged pro-Palestinian supporters to "stay away" from the festival.
The organisers say they will fund Tali Shalom Eze's trip instead, allowing her to show her film, Surrogate, this June.
In a statement, the festival bosses say they are "firm believers in free cultural exchange" and they "do not wish to restrict filmmakers"
The statement continued: "Although the Festival is considered wholly cultural and apolitical, we always acknowledge and consider the opinions of the film industry as a whole, and as such accept that one filmmaker's recent statement speaks on behalf of the film community."
Loach urged his boycott of the festival through the Scottish Palestine Solidarity Campaign, stating that "many film makers will be as horrified as I am to learn that the Edinburgh International Film Festival is accepting money from Israel."
He said: "With regret, I must urge all who might consider visiting the festival to show their support for the Palestinian nation, and stay away."
Loach has not yet responded to the news that the festival has returned the cash.
In the festival programme, Surrogate is described as "a startling vision of human damage and connectedness" which explores the relationship between a man and a woman who is employed to provide him with sexual therapy.
The film picked up an award at the International Women's Film Festival in Israel last year.