British businesses with investments in Iran face punitive sanctions from American authorities under proposed legislation expected to be approved by Congress in the coming months.

Companies that could be hit include Shell, the Anglo-Dutch oil group, as well as British banks such as Standard Chartered and HSBC.

The Bill is causing deep concern among diplomats in Washington who have sent officials to Capitol Hill warning about the possible consequences of igniting a transatlantic trade dispute.

American companies are already banned from doing business with Iran, but many European companies retain interests in the oil-rich Islamic Republic, which they regard as having the potential to become one of the world’s last great emerging markets.

The proposed legislation has attracted bipartisan support in Congress. It would implement the partially ignored 1998 Iran Sanctions Act, which allows for action to be taken against any business with investments worth more than $20 million (£9.7 million) in the country.

Some experts believe that any attempt to impose sanctions would be subject to legal challenges by the EU, while others suggest that existing trading links – as opposed to investment – would be unaffected.

The prospect of being denied trading rights in the US – a far more valuable market than Iran – has for nine years been avoided by the use of waivers issued to EU companies from both the Clinton and Bush Administrations.

Although the White House has sought to increase pressure on European companies to disinvest from Iran as part of a strategy to “quarantine” the Tehran regime, President Bush has continued to exempt such businesses from sanctions.

Senior US officials fear that draconian action could destroy the fragile multilateral alliance against Iran’s nuclear programme and its defiance of successive United Nations resolutions.

A diplomatic source said yesterday: “There are a lot of Democrats in Congress who want to be seen as doing something tough on Iran short of taking military action. We’re hoping that sensible people in the Administration will explain to them that this is not a good time to be falling out with their European allies who also want to stop Iran getting nuclear weapons.”

However, Tom Lantos, the Democrat chairman of the Foreign Affairs Committee in the House of Representatives, said that the President “has never sanctioned any foreign oil company that invested in Iran – those halcyon days for the oil industry are over”. He added: “The corporate barons running giant oil companies – who have cravenly turned a blind eye to Iran’s development of nuclear weapons – have come to assume that the Iran Sanctions Act will never be implemented. This charade now comes to a long overdue end.”

Shell’s plans to invest vast sums in the Persian Liquid Natural Gas project would almost certainly fall foul of the ban. A spokesman said yesterday: “We always seek to work within the law.”

HSBC and Standard Chartered, both of which have significantly reduced their profile in Iran over recent years, could be forced to close even the representative offices they have retained. Neither bank was prepared to comment yesterday.

The right-wing American Enterprise Institute in Washington said that Britain is ranked 17th in its league table of countries bolstering the Iranian economy, with $13 billion of trade between 2000 and 2007.

Frozen in time

1979: Islamic revolution topples the Shah, radical students seize the US Embassy in Tehran. US financial penalties include halting $12 billion of Iranian assets, some of which remain frozen

1984: Iran-Iraq war sparks banning of all loans to Iran

1995: President Clinton backs total embargo on any dealings with Iran

2000: Partial relaxation after election of reformist Iranian President Mahammad Khatami

2005: Sanctions tightened after President Ahmadinejad accelerates Iran’s nuclear programme

2007: Iran Sanctions Enhancement Act seeks further restrictions

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