Britain’s Ministry of Defence (MoD) has rejected a plea from the Foreign Office to hand over £400m owed by the UK government to Iran from a decades-old British tank sale, saying it is not prepared to give the money to the Iranian Revolutionary Guards Corps (IRGC), the Guardian understands.

The case is important because if the money were transferred, as an international arbitration court has ruled it should be, it is more likely that the jailed British-Iranian woman Nazanin Zaghari-Ratcliffe would be released.

Ministerial sources say the successive defence secretaries Sir Michael Fallon and Gavin Williamson have opposed releasing the payment, saying they are not prepared to hand over the money because they claim it will end up in the hands of Iranian forces determined to pursue what they see as a malign military agenda in Yemen, Syria and Lebanon.

It is the first time there has been such a clear political, as well as legal, motive ascribed to the MoD’s refusal to hand over the money.

Iranian authorities have not made an explicit link between the outstanding payment and the fate of Zaghari-Ratcliffe, who is serving a five-year jail sentence for espionage, but in private Iranians cite the £400m as one reason for the lack of trust between Tehran and London.

The UK and Iran put their legal arguments about the payment to a high court hearing last week and a ruling is expected soon.

The IRGC is the military wing of the Iranian government. It has been declared a terrorist organisation by the US, but not by the UK.

One source said the records would show there had been some heated exchanges between the Foreign Office and the MoD about the debt.

Some members of the government have argued that the UK lost the international arbitration case, owed the money and had to show a willingness to work with Iran.

It was pointed out that the UK is actively trying to set up a special purposes vehicle designed to ease trade between Iran and the UK, so should not join a US economic blockade of Tehran.

It was also argued the money could be given to Iran by the UK in a way that avoids current EU sanctions, a case UK government lawyers do not accept.

Lawyers for Zaghari-Ratcliffe’s husband, Richard Ratcliffe, have frequently pressed UK ministers to discuss the means by which the debt could be paid to an Iranian government entity other than its ministry of defence, or through humanitarian channels. Another option is for the UK Treasury’s office of financial sanctions to issue a licence that would make the payment permissible under EU law.

At the weekend, the veil of secrecy over the decades-old dispute was lifted when the Sunday Times won a court order allowing the arguments in the case to be published, a decision welcomed on Tuesday by Ratcliffe.

Timeline Imprisonment of Nazanin Zaghari-Ratcliffe in Iran Show Hide Arrest in Tehran Nazanin Zaghari-Ratcliffe is arrested at Imam Khomeini airport as she is trying to return to Britain after a holiday visiting family with her daughter, Gabriella. Release campaign begins Her husband, Richard Radcliffe, delivers a letter to David Cameron in 10 Downing Street, demanding the government do more for her release. Sentenced She is sentenced to five years in jail. Her husband says the exact charges are still being kept a secret. Hunger strike Nazanin Zaghari-Ratcliffe's health deteriorates after she spends several days on hunger strike in protest at her imprisonment. Appeal fails Iran’s supreme court upholds her conviction. Boris Johnson intervenes Boris Johnson, then Foreign Secretary, tells a parliamentary select committee "When we look at what [she] was doing, she was simply teaching people journalism". Four days after his comments, Zaghari-Ratcliffe is returned to court, where his statement is cited in evidence against her. Her employers, the Thomson Reuters Foundation, deny that she has ever trained journalists, and her family maintain she was in Iran on holiday. Johnson is eventually forced to apologise for the "distress and anguish" his comments cause the family. Health concerns Her husband reveals that Zaghari-Ratcliffe has fears for her health after lumps had been found in her breasts that required an ultrasound scan, and that she was now “on the verge of a nervous breakdown”. Hunt meets husband New Foreign Secretary Jeremy Hunt meets with Richard Ratcliffe, and pledges "We will do everything we can to bring her home." Temporary release She is granted a temporary three-day release from prison. Hunger strike Zaghari-Ratcliffe is on hunger strike again, in protest at the withdrawal of her medical care. Diplomatic protection The foreign secretary, Jeremy Hunt, takes the unusual step of granting her diplomatic protection – a move that raises her case from a consular matter to the level of a dispute between the two states. Travel warning The UK upgrades its travel advice to British-Iranian dual nationals, for the first time advising against all travel to Iran. The advice also urges Iranian nationals living in the UK to exercise caution if they decide to travel to Iran. Hunger strike in London Richard Ratcliffe joins his wife in a new hunger strike campaign. He fasts outside the Iranian embassy in London as she begins a third hunger strike protest in prison. Hunger strike ends Zaghari-Ratcliffe ends her hunger strike by eating some breakfast. Her husband also ends his strike outside the embassy.

Moved to mental health ward According to her husband, Zaghari-Ratcliffe was moved from Evin prison to the mental ward of Imam Khomeini hospital, where Iran’s Revolutionary Guards have prevented relatives from contacting her. Daughter returns to London Zaghari-Ratcliffe's five year old daughter Gabriella, who has lived with her grandparents in Tehran and regularly visited her mother in jail over the last three years, returns to London in order to start school. Temporary release Amid the threat of the coronavirus pandemic, she is temporarily released from prison, but will be required to wear an ankle brace and not move more than 300 metres from her parents’ home. New charges Iranian state media reports that she will appear in court to face new and unspecified charges. In the end, a weekend court appearance on a new charge of waging propaganda against the state that could leave her incarcerated for another 10 years is postponed without warning, leading Zaghari-Ratcliffe to say "People should not underestimate the level of stress. People tell me to calm down. You don’t understand what it is like. Nothing is calm."

The court papers show Iran had asked the Treasury to approve the payment from a government-owned defence company to the Central Bank of Iran. Iranian officials believe the payment can be made without breaching EU sanctions.

The dispute is over a 1970s defence deal between the Iranian defence ministry and a now near-defunct UK government defence trading service, International Military Services.

IMS signed contracts in 1971 to sell more than 1,500 Chieftain tanks and armoured vehicles to the Shah of Iran. The contracts were cancelled after the shah was deposed in the 1979 revolution but Iran had already paid for the undelivered tanks and demanded its money back.

It won an arbitration case at the Hague-based international chambers of commerce in May 2001 for repayment of the funds, but IMS, acting on behalf of the UK government, appealed against the size of the settlement.

To avoid contempt of court charges, the IMS agreed in December 2002 to pay money to the high court as security, but there is now a dispute over the interest to be paid on the sum. In addition, the MoD said even if an agreement on the amount payable was reached, the money could not be handed to Iran’s military sales arm because the body is under EU sanctions.

The foreign secretary, Jeremy Hunt, said there had never been a government policy to keep the court hearings private, rather, it was just normal legal practice for such arbitration cases to be held in private. “We are very happy for it to be public,” he told BBC Radio 4’s Today programme on Tuesday.

Hunt, who has claimed that Zaghari-Ratcliffe is being used as a diplomatic pawn in a wider dispute between Iran and the UK, appeared to liken any handover of the debt to ransom money.

“The problem is if you pay ransom money to someone who is a hostage then all that happens is you might get that hostage out, but the next time they want something they’ll just take someone else hostage. That is the conundrum we have.”

Ratcliffe’s supporters said Hunt’s description of the payment as ransom money was surprising given the government acknowledges that a payment is owed and that this predates Zaghari-Ratcliffe’s case by more than a decade.

Zaghari-Ractliffe was convicted in Iran in September 2016 on spying charges, which she denies.

Ratcliffe said that until the Sunday Times intervened, the government would not even tell parliament the day the hearing was happening. Ministers also gave a succession of written answers insisting the proceedings must remain private and confidential since they concerned an arbitral award.

Ratcliffe said the case “matters to us since we have been told explicitly that we are linked to this court case. It feels like we are a very explicit bargaining chip that is being used.”

In a Westminster debate in March 2014, Ben Wallace, who was then a backbencher but is now a security minister, described the British handling of the case as “un-British since it has been marred by double dealing and obfuscation”.

During his time as foreign secretary, Boris Johnson had briefed selective journalists that the money would be paid, but then discovered he could not deliver on the commitment because of resistance from government lawyers and the MoD.

• This article was amended on 31 May 2019 to amend a time period.