But Yaacov Edri, the minister of immigrant absorption, denounced the transfer, saying the funds would be used by Hamas for "terrorist  operations."

Israel transfers around $75 million a month to the Palestinian Authority (PA) in taxes and customs duties it collects on behalf of the Palestinians.

The funds are used to pay the more than 160,000 civil servants in the occupied West Bank and Gaza.

Broader plan

Meanwhile, the Israeli daily Haaretz reports that Ehud Olmert, the Israeli prime minister, has offered the Palestinians a peace plan giving them 93 per cent of the occupied West Bank.

The proposed border is at the heart of a broader plan that would compensate the Palestinians with the equivalent of 5.5 per cent of the West Bank adjacent to the Gaza Strip and a route connecting Gaza to the West Bank itself, according to the report.

However, the PA would only receive the land and the overland connection once its forces retake the Gaza Strip from Hamas, which seized power in the coastal territory in June 2007.

The proposal has been offered in the context of US-backed peace talks relaunched in November with the goal of resolving the decades-old conflict by the end of the year.

The proposed agreement, however, would be a "shelf agreement" to be implemented in the coming months and years, and would not immediately include the thorny issue of the future status of Jerusalem, Haaretz said.

'Undivided capital'

The Palestinians have demanded mostly Arab east Jerusalem, which Israel occupied and annexed in the 1967 Six Day War, as their capital, while Israel considers the entire Holy City its "eternal, undivided" capital - a claim not recognised by the international  community.

The agreement would, however, include a complex solution to the Palestinian refugee problem, allowing some refugees from the 1948 war to return to Israel while settling most of the 4.5 million refugees in the Palestinian state.

The seven per cent of the West Bank annexed by Israel would include the major settlement blocs around Jerusalem - home to most  of the 250,000 Israeli settlers in the territory - and some settlementsin the northern West Bank.

The final Palestinian state would be demilitarised.