The Government has suffered an embarrassing defeat in the Lords as peers voted for controversial clauses in the Trade Union Bill, which would restrict funding of political parties, to be considered by a select committee.
Peers voted 327 to 234, to give a majority of 93 to a Labour motion forcing the unusual parliamentary move.
Labour fears its annual income could fall by £6 million, as the legislation would require Labour-affiliated union members to "opt in" to paying a levy to the party instead of having it automatically deducted.
Labour's Baroness Smith of Basildon claimed democracy would be damaged if the Government pushed through the changes on funding without the situation being scrutinised by an all-party select committee first.
Lady Smith said the select committee should report by February 29, and would not hinder progress of the full Bill.
The Labour peer insisted it would be better to examine the issues involved in a select committee, rather than seeing "who can shout the loudest" on the floor of the house.
Lady Smith dismissed Government claims that it did not expect the Bill to impact financially on the Labour Party.
"We believe the Government is wrong - or at the very least, in denial, of the consequences.
"Our genuinely held concern is that this aspect of the Bill will have a significant impact on the resources of one major political party - my party, the Labour Party.
"And in doing so, it will both disrupt the political balance in the UK and have a damaging effect on the electoral process and our democracy," the Labour peer said.
Labour is also reported to be set to lose out by about £1.3 million a year when state funding for opposition parties - known as Short money - is cut.
Press Association
