The body examining the practices of the car industry following the Volkswagen emissions scandal has been accused of a major conflict of interest after it emerged that nearly three quarters of its funding comes from the companies it is investigating.

According to its latest annual report, the Vehicle Certification Agency receives 69.91% of its income from car manufacturers, who pay it to certify that their vehicles are meeting emissions and safety standards.

The transport secretary, Patrick McLoughlin, said last month that the VCA, which also receives government funding, would be responsible for re-running tests on a variety of makes of diesel cars and investigating their real-world emissions.

The announcement followed the revelation from the US Environmental Protection Agency last month that Volkswagen had installed illegal software to cheat emission tests, allowing its diesel cars to produce up to 40 times more pollution than is permitted.

However, the apparent conflict of interest raised by VCA’s funding has prompted lawyers to demand a truly independent investigation into the industry, and will raise fresh concerns over the government’s handling of the issue of air pollution.

Last week the Observer revealed how the government has been seeking to block EU legislation that would force member states to carry out surprise checks on car emissions. It has also been accused of ignoring a supreme court ruling that the government needed to urgently draw up significant plans to tackle the air pollution problem, which has been in breach of EU limits for years and is linked to thousands of premature deaths each year.

Alan Andrews, a lawyer at ClientEarth, said the VCA’s funding sources made it an inappropriate body to investigate the car industry. He said: “These figures show the agency relies for funding on the very industry it is meant to be investigating. We need a robust, transparent and independent investigation into whether the use of so-called ‘defeat devices’ are widespread in the UK car industry.

“Transport secretary Patrick McLoughlin must act now to ensure an outside body investigates this scandal. We cannot continue to risk the health of thousands of people a year by allowing watchdogs to have a too cosy and too close relationship with polluters.”

The scandal has wiped more than a third off Volkswagen’s share price, forced the resignation of its chief executive and been the source of huge embarrassment for the German chancellor, Angela Merkel, who was accused of being too close to Europe’s biggest car manufacturer.

Volkswagen has revealed that 1.2m vehicles in the UK are involved in the emissions scandal, which means that more than one in 10 diesel cars on the road are affected. It said the diesel vehicles include 508,276 Volkswagen cars, 393,450 Audis, 76,773 Seats, 131,569 Škodas and 79,838 Volkswagen commercial vehicles.

According to research compiled by Adac, Europe’s largest motoring organisation, diesel cars from Renault, Nissan, Hyundai, Citroën, Fiat, Volvo and other manufacturers have also been found to emit substantially higher levels of pollution under more realistic driving conditions. There is no suggestion of cheating, but only a quarter of the 79 cars Adac tested matched official results on the existing EU test.

A Department for Transport spokesman said: “To help provide value for taxpayers, the VCA cover their operating costs by charging manufacturers for the services they provide. This is the case with many regulators, including the ORR. Whilst the VCA charges the industry for its services, its governance framework is set by Government.”