Two US men have been charged in the US with operating an illegal front group for the Pakistani government.
The two used at least $4m (£2.5m) in Pakistani funds in a bid to influence the US position on the disputed territory of Kashmir, prosecutors said.
Ghulam Nabi Fai, 62, was arrested and charged with failing to register as a foreign government agent. Zaheer Ahmad, 63, was charged with the same offence.
Pakistan rejects the charges. Kashmir is at the centre of its row with India.
Mr Fai, who denies the charges, is a US citizen who comes from Indian-administered Kashmir. Mr Ahmad is a US citizen of Pakistani origin.
Correspondents say the case is likely to worsen already strained relations between Washington and Islamabad.
The killing in Pakistan of Osama Bin Laden by US forces in May angered many in Pakistan, and left US officials questioning whether Pakistani intelligence had known about the al-Qaeda leader's whereabouts.
Since the raid, there have been a number of arrests in Pakistan of people alleged to have worked with US intelligence. The BBC's M Ilyas Khan in Islamabad says many in Pakistan view the arrest of Mr Fai as part a "tit-for-tat" row between the two countries.
The US said Mr Fai's Pakistani handlers funnelled millions of dollars from the country's intelligence agency, the ISI, through a front group, the Kashmiri American Council.
"Mr Fai is accused of a decades-long scheme with one purpose - to hide Pakistan's involvement behind his efforts to influence the US government's position on Kashmir," US Attorney Neil MacBride said.
The group contributed money to US election campaigns, helped fund conferences and other efforts, including meetings with White House and state department officials, the US alleges.
An FBI agent said the government of Pakistan paid Mr Fai $500,000 to $700,000 a year.
Officially, the Kashmiri American Council had a much smaller budget and it said that it received no foreign grants.
The Pakistani embassy in Washington issued a statement denying any government knowledge of such an arrangement.
"Mr Fai is not a Pakistani citizen and the government and embassy of Pakistan have no knowledge of the case involving him," the statement said.
A separatist leader in Kashmir, Syed Ali Shah Geelani, told the Associated Press on Wednesday that Mr Fai was innocent and called the allegation the "result of India's diplomatic efforts and conspiratorial plans."
Prosecutors said the second man, Zaheer Ahmad, recruited people to act as donors who would give money to the council which really was coming from the Pakistani government. He is not under arrest and is believed to be in Pakistan.
Kashmir has been a flashpoint between India and Pakistan for decades. Both countries claim the territory in its entirety and have fought two of their three wars over it.