“We’ve not finalised agreement on the current round of funding and no final decisions have been made,” AFP news agency quoted spokesman Philip Crowley as saying.

The Washington Post newspaper earlier reported that a state department official had confirmed the offer to GIFC, whose Freegate and Ultrasurf software allows users to circumvent government-imposed internet controls around the world.

The controversy comes as the first US-China human rights talks in two years are set to resume in Washington.

The question of China’s internet censorship is expected to be among issues raised during discussions.

Internet search giant Google shut down its mainland Chinese search service, google.cn, earlier this year amid concerns over censorship and now directs users to its unrestricted Hong Kong site.

‘Fabricated lies’

Wang Baodong, a spokesman for the Chinese embassy in the US capital, said he believed his government would “raise serious representations” with its US counterparts on the issue of the Falun Gong.

“GIFC is an organisation run by elements of the Falun Gong cult, which is bent on vilifying the Chinese government with fabricated lies, undermining Chinese social stability and sabotaging China-US relations,” he said.

“We’re strongly opposed to the US government providing whatever assistance to such an anti-China organisation.”

He said China’s regulation of the internet was in line with its laws and those of many other countries, and was supported by the vast majority of its people.

Falun Gong, which combines meditation with Buddhist-inspired philosophy, has been banned in China since 1999 for carrying out “illegal activities”.

‘Battle of resources’

In recent months, the state department has faced pressure to assist GIFC from members of Congress, including five US senators who wrote to Secretary of State Hillary Clinton on the issue, and some human rights campaigners.

Supporters of GIFC say that with more resources, its systems – which currently have the capacity to serve about 1.5m people a day – could give millions more people in countries such as China, Iran, Syria and Cuba unrestricted access to the internet.

Dr Zhou, deputy director of GIFC, told the BBC that the $1.5m offered was much less than the $4m the group had hoped for and would not allow it significantly to expand its capacity by boosting staffing and equipment.

“We are up against a multi-billion dollar effort from China – they have tens of thousands of internet monitors,” he said.

For every dollar the group spends, China will spend hundreds of dollars to counter its efforts, with the result that the battle for internet freedom has become one of resources, he said.

He added that although the group was largely made up of Falun Gong practitioners, they followed its teachings as individuals, without a political agenda.

Michael Horowitz, a fellow of the Hudson Institute, a conservative Washington-based think tank, believes the US government is doing too little to support GIFC’s work.

He told the BBC that the state department had since last October been sitting on $30m in funds appropriated by Congress to advance internet freedom.

Mr Horowitz, a former Reagan administration official, argues that if GIFC were given that $30m, it could expand its systems to provide internet freedom to 50m people daily.

“The US has the capacity to give 50m Chinese the capacity to have uncensored Google [access] and the US is refusing to do it,” he said.

He said Obama administration officials had argued first that it was impossible to beat the firewalls, and then that censorship was only one of a number of issues to be tackled, and so was not a priority now.

In answer to a question put by Democratic Senator Arlen Specter, Mrs Clinton said last week that a “multi-faceted approach” was needed on internet freedom policy.

Many people involved in organising protests following Iran’s disputed presidential elections last June were able to access websites like Facebook and Twitter using GIFC software, after a government crackdown on internet use.

“The walls of the 21st Century are electronic,” Mr Horowitz said.

“You have to have a certain critical mass of user freedom before you shatter internet firewalls and that can only be done with the money that Congress gave the state department in October last year.”