The Learning and Skills Council wants a simpler, more flexible system but the Government says cash must be targeted better to meet the immediate skills training needs of industry.
Sources in the Department for Education and Skills say there has been a row with the LSC over where responsibility for making policy stops and implementation begins.
A funding system that is more responsive to employers was proposed in the recent FE white paper. An FE Bill, expected early in 2007, will set out such "demand-led" plans.
But Mark Haysom, chief executive of the LSC, is said to be concerned that this approach could damage colleges and other providers, removing rather than increasing flexibility. He is understood to have met further and higher education minister Bill Rammell and is raising concerns with principals at his summer roadshows.
Principals at the roadshows, say they fear a return to the market-driven policies of the mid-1990s that pushed many colleges and training companies near to bankruptcy. "Everything seems to be driven now by an acceptance that what employers say goes," said the principal of a large West Midlands college.
A south London principal said: "The last time we had a demand-led approach, we had colleges abandoning much-needed construction and other key courses for the latest business fad, because that was the safest way of guaranteeing they got the money."
A spokesman for the DfES denied there was a rift with the LSC. "Changes will be part of a planning-led programme under the LSC's Agenda for Change," he said. "Everyone supported the demand-led proposal when it was made. Colleges must provide the skills employers need and it is a government priority to rebalance the budget. By 2015, the bulk of training supply will be demand led."
Rob Wye, strategy and communication director for the LSC, said the council was "in discussions" with the DfES to make sure implementation worked.
"There is much to sort out," he said. "We need to look at what planning and funding mechanisms are necessary to make this happen.
"Should there be in-year budget adjustments? Do we need real-time funding? Or should we say no money changes hands until the learners turn up? We are flagging-up the need to consider the pros and cons of all such issues."
The Association of Colleges insists that colleges already respond to individual demand. John Brennan, AoC chief executive, said: "We have no problem with being responsive to company demands and meeting their needs.
But we do not want to see a system that is hugely bureaucratic with yet more new administrative and accountability rules."
He is concerned that the new pound;740 million Train to Gain scheme, giving free training to companies, "will create a parallel structure to existing funding allocations and mechanisms which will be unhelpful to colleges and other providers.
"We need a simple system where we agree with the LSC on the targets for delivery, the funding structure to help make it happen and mechanisms to make sure payments are justified."