The government is to insert a clause into all grant agreements preventing such funds from being used by charities to lobby government, the Minister for the Cabinet Office, Matthew Hancock, announced.
Whitehall departments will have to insert a clause into all new or renewed grant agreements from 1 May spelling out that the funding cannot be used to fund activity intended to attempt to influence parliament, government or political parties.
Sir Stuart Etherington, chief executive of the National Council for Voluntary Organisations, said the move was "tantamount to making charities take a vow of silence", and could be more damaging to the sector than the lobbying act. Labour said it was "an outrageous attempt to further curb the independence of charities".
The Charity Finance Group said the clause would breach the Compact and a group of more than 130 charities and umbrella bodies subsequently wrote a joint letter to David Cameron, the Prime Minister, calling for a rethink.
The Cabinet Office said the think tank the Institute of Economic Affairs had carried out extensive research on "sock puppets", which the department said "exposed the practice of taxpayers' money given to pressure groups being diverted to fund lobbying rather than the good causes or public services". It said the clause would ensure tax money was spent on improving people's lives and good causes rather than lobbying for new regulation or for more government funding.
The clause will say: "The following costs are not eligible expenditure: payments that support activity intended to influence or attempt to influence parliament, government or political parties, or attempting to influence the awarding or renewal of contracts and grants, or attempting to influence legislative or regulatory action."
Any organisation that breached the terms of the new clause might have remaining payments cancelled, the Cabinet Office said. It said the new rules would not stop organisations using their own privately raised funds to lobby.
Hancock said the rules would protect freedom of speech, but ensure taxpayers would not pay for political campaigning and lobbying. "Taxpayers' money must be spent on improving people's lives, not wasted on the farce of government lobbying government," he said.
The joint letter from the heads of more than 130 charities, including Oxfam, the British Red Cross, Guide Dogs and Save the Children, was signed by Campbell Robb, chief executive of Shelter, which was cited in the government's press release as an example of a charity that had been operating under the new rules in a pilot with the Department for Communities and Local Government.
The letter said the proposals were "flawed in principle, for they may actually cost the taxpayer more money through limiting the range of insight that policymakers can draw upon".
Andrew O'Brien, head of policy and engagement at the Charity Finance Group, said the change contravened the Compact, the agreement between the government and the voluntary sector that sets out how they should deal with each other.
The Compact, signed by the Prime Minister in December 2010, says the government will "respect and uphold the independence of civil society organisations to deliver their mission, including their right to campaign, regardless of any relationship, financial or otherwise, which may exist".
Rob Wilson, the Minister for Civil Society, said the clause was "absolutely compatible with the Compact because it does not restrict the rights of charities to campaign on behalf of their beneficiaries".