The charity watchdog has ruled Birmingham-based charity Islamic Help was operating outside its charitable objects in raising money for a school at Brierfield Mills.

In a hard-hitting decision, the commission has ordered donations to be returned to those who responded to the appeal for funds.

People thinking about donating were told £500 would go towards student accommodation, £5,000 towards a classroom and £20,000 towards a computer lab.

Pendle MP Gordon Prentice called in the commission, insisting Islamic Help was breaking charity law in asking for money for a purpose outside its charitable objects.

The charity bought Brierfield Mills, the Grade II listed former Smith and Nephew fabrics factory, in December for £1,020,000 plus VAT.

Sultan Niaz Ul Hassan, a trustee of Islamic Help and one of the new registered owners, told the commission none of the money raised in the website appeal for funds for the Pendle Boarding School for Girls had been used for the purchase. Instead, the charity had secured a bank loan of £650,000 from Lloyds TSB and the balance apparently came from pledges and backdated gift aid.

The commission is insisting the £10,000 which Islamic Help says was raised in the fund-raising appeal must be returned to those who gave the money. Where this is not possible – as money was donated anonymously – it must go into a special pot and the approval of the commission must be given before it can be used for any another purpose.

The commission has also ordered Islamic Help to remove the appeal for funds for the Pendle School for Girls from its website.

Mr Prentice said: "There was never any doubt in my mind that Islamic Help was operating on the wrong side of charity law. Fund-raising for a huge school was way outside their charitable objects.

"Ghausia Girls' School will not now be moving to Brierfield Mills and expanding to take 200 students 'in the early stages' as some people were predicting.

"I am told Brierfield Mills will now be used as a warehouse for clothing collections and some parts could be leased at a commercial rent. There may be community facilities as well but, as always, I put aside the hype and I wait for the detailed plans.

"We have already had too much smoke and mirrors.

"I shall be raising this issue in Parliament. I want to see a full audit of the finances of Islamic Help. And I want the Charity Commission to maintain an oversight and supervisory role.

"I am also left wondering what kind of assurances were given by the charity to Lloyds TSB (57% privately owned) to secure the £650,000 loan."