A case being investigated by the European Court of Justice could have crippling effects on British science.
The advocate general, an officer of the court, has challenged Germany's value-added tax exemption for research carried out by universities, saying it breaches European Union law.
If the European Court agrees, universities across Europe could be forced to charge VAT on contract research carried out for eligible bodies such as governments or charities.
This outcome could be good for some research-intensive universities as they will be able to recover research costs and overheads by offsetting their VAT.
But Frank Hartley, VAT partner at accountancy firm Grant Thornton, warned:
"With universities and other research budgets able to claim a refund of the VAT charged to it, government may take the decision to reduce funding. This would have a critical and potentially detrimental effect on research institutions that rely heavily on this income."
Government departments can reclaim VAT, but non-profit-making funders that cannot may find they have less money available to support research.
Capital-intensive research, such as engineering and pure science, would be most likely to suffer as medicine and veterinary science already get limited VAT relief.
Grant Thornton recommended that UK universities replace research contracts with service-level agreements or even grants if they are forced to charge the 17.5 per cent VAT.
The United Kingdom's VAT exemption is more limited than Germany's, which depends on whether supplies of research are closely related to education. In the UK, only research commissioned by eligible bodies for eligible bodies is VAT-exempt.
Peter Cotgreave, director of the lobby group Save British Science, said: "I have no doubt whatsoever that if the ruling goes against Germany and the UK's rules are deemed to be caught in the same trap, the net effect will be bad for British science."
A spokesman for Universities UK said it was investigating the implications of a ruling for research. He said: "This is of particular concern to us in the current climate of uncertainty over how funding will be allocated following the outcome of the 2001 research assessment exercise."