Ministers fear the tax could cost 10,000 jobs if it is introduced in the UK and has threatened to use its European Union veto to block it if necessary.

But the House of Lords European Communities Committee has expressed "serious doubts" that the government's preferred alternative would work.

It has warned that a proposed compromise approach by the European Commission could simply prove to be a "disingenuous" ploy to introduce the tax by the back door.

The commission wants to introduce the tax on savings across the European Union so that citizens in countries such as Germany - which already have the tax - do not simply move their savings to other member states to escape paying it.

Britain, however, has warned that the introduction of a withholding tax would drive out the City of London's lucrative Eurobond market with the loss of thousands of jobs.

Instead ministers want to get round the problems of tax evasion by allowing member states to adopt a system of reporting.

Under this system, member states would be required to inform the tax authorities of other EU nations of any savings by non-residents so that they could be taxed on them in their country of residence.

'Serious doubts'

However, the Lords committee warned that a mixed system advocated by Britain - with some members adopting the withholding tax and others the reporting system - was unlikely to work.

Chancellor Gordon Brown has said he would veto the tax if necessary

While revenue from a withholding tax would go to the member state where the savings were held, under the reporting system the country of residence would receive the revenue from whatever tax it chose to impose, the peers said.

Therefore - unless withholding tax receipts were passed to the country of residence of the person with the savings - there would be a financial incentive for states to adopt the withholding tax as they would get more revenue.

"We have serious doubts that a co-existence model [with some member states adopting the withholding tax option and others the reporting option] could work in the form currently proposed," the committee warned.

"The problem of distributing revenue is a major one, which the commission's proposal does not address.

"We are puzzled by this, and we wonder whether it results from a wish to press all member states into adopting the withholding tax rather than the alternative route: if so, we would regard it as disingenuous."

'Secret taxation scares'

The committee also complained about the way a highly sensitive European ministerial group chaired by Paymaster General Dawn Primarolo, examining potentially "harmful" tax competition in the EU, operated.

It said the secrecy shrouding the work of the Code of Conduct Group had led to the proliferation of press "scare stories".

"We think the lack of transparency in the handling of this matter shows both the Council of Ministers and the government in a very poor light," the committee said.