EU leaders are preparing for acrimonious talks on the bloc’s seven-year budget amid deepening divisions between the self-styled “frugal” club and a larger number of countries fighting cuts.

The EU’s 27 leaders will attempt to agree a budget for 2021-27 at a special summit on Thursday, the first such exercise since Brexit blew a €70bn (£58bn) hole in the finances. “It is an exercise in the division of loss, a bit like Brexit,” a senior EU diplomat said.

The European council president, Charles Michel, has taken the high-risk strategy of calling the special one-day summit, which could drag into the weekend if there is a chance of a deal. “We don’t have the intention to keep them imprisoned,” an EU official said. “They are there for the time it will take.”

Brussels budget squabbles are nothing new, but Thursday’s summit threatens to be the most difficult yet. The EU is seeking to spend more on tackling the climate emergency, research and border security, while facing demands to maintain spending on farmers and infrastructure for poorer member states, and dealing with the Brexit black hole.

“The facts are the facts,” said the EU official. “We face a €60-75bn gap [over 2021-7] because of Brexit, we are facing new challenges and demands for which money is needed and … the member states have a tight budgetary situation. So realism is needed.”

Adding another layer of division, western countries want better oversight of EU funds, so governments that flout the rule of law by weakening independent courts would lose EU funds. Some claim that Michel has gone too far in weakening an original mechanism to ensure that recipients of cohesion funds act in accordance with the rule of law.

The budget battle pits the self-styled “frugal four” – net payers Austria, Denmark, Sweden and the Netherlands – against “the friends of cohesion”, 15 southern and eastern European countries that seek at least to preserve current agricultural and infrastructure spending.

The two largest net payers (by size of contribution) are outside both camps. France wants to maintain agricultural spending and boost EU defence funds. Germany wants a speedy agreement, to avoid having to solve the budget during its EU presidency in the final six months of the year. “The Germans face a dilemma,” said the senior EU diplomat. “They don’t want to own this hot potato. But will they pay up just to avoid it?”

As well as the Brexit gap, the UK leaves another poisonous legacy: the rebate. After Margaret Thatcher secured the British rebate in 1984, some other countries were granted one, effectively a discount on their EU membership fee. While the European commission proposed sweeping away all “corrections”, Michel has proposed that five net payers should keep their rebates. “The rebate is not there just for fun. It is there because otherwise things would really get out of hand and off the scale,” said a diplomat from one country that gets a rebate.

Other countries, including net payers such as France, think the rebate has had its day. “Why these five countries? Just because they already had one [a rebate],” said another diplomat. “It is very unfortunate that we continued with this tinkering.”

Although the arguments are big, the sums are relatively small. The “frugal four” want to limit the EU budget to 1% of the EU’s economy, as measured by gross national income (GNI). The European commission proposed 1.11% of GNI, while Michel has almost split the difference with his 1.07% compromise plan.

“We have a plan”, said an EU diplomat from one of the self-styled frugal member states. “Plan A is the 1% and the rebate. And we have a plan B which is 1% and the rebate.” The “frugal four” argue that while they are content to be net payers to the seven-year budget, the additional contributions being sought by Michel put an intolerable burden on their taxpayers. The Dutch estimate that the proposals put forward would increase their contribution by 20%.

The battle threatens to be even more ferocious than that in 2013 when David Cameron helped force through the first-ever cut in the EU’s budget. EU diplomats outside the frugal camp argue the previous austerity budget means a low starting point. “Is there really a collective will to act?” asked one diplomat. “We are facing a failure of collective ambition.”

The diplomat said 22 countries thought the Michel compromise was not enough while five found it too much, adding: “The balance is not necessarily in the middle.”

But the frugal four insist they will not compromise, despite being a minority. “Whose money are you going to spend? In any negotiation you need the investors onboard otherwise you won’t get an agreement,” said one frugal diplomat.

Hours before the summit, few EU insiders were banking on a deal. Michel has warned EU leaders in private meetings that failure to find agreement imperils current and new EU programmes due to start in 2021.

“It looks like quite a big gap to reach,” said one of the frugal diplomats. “If not, then we will have to come back a second time, which is not something special because it’s quite normal to not manage it.”

Another diplomat, worried about “unpleasant” media headlines, asked: “Do we want such a fiasco when the numbers are going to be the same in March and April?”