Theresa May is facing a demand from Conservative Brexiteers to drop one of the government's preferred post-Brexit customs options.
A 30-page document passed to the BBC says a "customs partnership" would make meaningful trade deals "impossible" to forge and render the UK's International Trade Department "obsolete".
It came ahead of a key meeting of senior ministers about Brexit.
The committee discussed rival options to replace customs union membership.
Afterwards, a source told BBC political editor Laura Kuenssberg that a narrow majority of those at the meeting had said the customs partnership was not viable, and it was suggested it would not be taken back to full cabinet for further discussion.
But Downing Street sources said the meeting agreed that this option and the proposal for a "highly streamlined" arrangement were still "serious propositions", although they acknowledged there were "challenges that need to be addressed".
Theresa May is understood to have asked for "revised proposals", our correspondent added.
1. What did the meeting achieve this afternoon? Hear PM has asked for 'revised proposals' further work on both options, No 10 sources suggest both still on the table but...— Laura Kuenssberg (@bbclaurak) May 2, 2018
2. Also being told customs partnership model was rejected and won't go back full cabinet, suggested Williamson and Javid both spoke against it outlining 'significant' and 'grave concerns'— Laura Kuenssberg (@bbclaurak) May 2, 2018
3. So already different versions out there of what happened at the meeting - but certainly the proposals as they currently exist are not viable with Number 10 agreeing they need more work— Laura Kuenssberg (@bbclaurak) May 2, 2018
4. So nearly 2 years on, govt accepts it doesn’t have viable customs plan yet - v interesting that Javid seems to have been on Brexiteers side - new Home Sec at his first meeting of that committee— Laura Kuenssberg (@bbclaurak) May 2, 2018
What is a customs union?
All EU members are part of the customs union, within which there are no internal tariffs (taxes) on goods transported between them. There is also a common tariff agreed on goods entering from outside.
The UK government has said it is leaving the EU customs union so will have to agree a new arrangement for what happens at the UK/EU border post-Brexit and whether businesses will be hit with tariffs or not.
The complicating factor is that the UK wants to strike its own post-Brexit trade deals with other countries rather than have to stick with deals struck for the EU customs union.
The government's two options
- A 'highly streamlined' customs arrangement - This would minimise customs checks rather than getting rid of them altogether, by using new technologies and things like trusted trader schemes, which could allow companies to pay duties in bulk every few months rather than every time their goods cross a border
- A customs partnership - This would remove the need for new customs checks at the border. The UK would collect tariffs set by the EU customs union on goods coming into the UK on behalf of the EU. If those goods didn't leave the UK and UK tariffs on them were lower, companies could then claim back the difference.
Government sources say the situation is constantly evolving. It is possible another option could emerge combining elements of the first two. But any solution would aim to avoid the need for physical border checks on the island of Ireland.
Wednesday's cabinet sub-committee meeting may not reach a final decision on the proposals - and don't forget, this is all about the UK agreeing its stance before more Brexit talks. The EU does not appear to be keen on either option.
Speaking at Prime Minister's Questions, Theresa May said there were "a number of ways" to deliver Britain's objectives on customs arrangements after Brexit.
Who backs the customs partnership idea?
The BBC's economic editor Kamal Ahmed says he understands Chancellor Philip Hammond (pictured above) favours a customs partnership. Mr Hammond and other Remain-voting cabinet ministers, such as business secretary Greg Clark, are hoping to persuade the prime minister to keep it on the table when the 11-strong Brexit sub-committee meets later.
Remain-voting Tory backbenches also want it to remain an option. One of them, Vicky Ford, told BBC Radio 4's Today programme it did not mean remaining in the EU "by the back door" as critics claim and could protect British business.
Who is against it?
Brexiteer cabinet ministers such as Boris Johnson, Liam Fox (pictured above) and David Davis - and a group of Conservative backbenchers led by Jacob Rees-Mogg, whose Tory Research Group produced the dossier sent to Mrs May.
The Cabinet all signed up to the two customs options when they were announced last year but some are now thought to be worried that the customs partnership idea would mean a slide towards remaining in the customs union.
Backbench Tory Brexiteers fear the scheme would be expensive and complex to operate, and could mean the UK is indefinitely trapped within the EU's customs arrangements - and unable to strike its own post-Brexit trade deals with other nations around the world.
Mr Rees-Mogg said it would not only be "unworkable", it would the same as staying in the EU and was the "single market by another name".
Housing minister Dominic Raab told BBC Radio 5 Live's Anna Foster the "streamlined" customs option was "winning the argument" in government as it was "the one that's been tried and tested the most".
Could the government fall over this?
According to the Press Association, Downing Street has been privately warned that a customs partnership could collapse the government, as committed Brexiteers on the Tory backbenches regard it as unacceptable.
A senior Conservative told the BBC's Political Editor Laura Kuenssberg "the customs partnership is the breaking point", suggesting that if No 10 doesn't do the Brexiteers' bidding, they could withhold their support.
On Tuesday, International Trade Secretary Liam Fox refused to deny he would resign if a customs partnership was agreed in an interview with BBC Radio 4's Today programme.
Have Tory MPs set Theresa May an ultimatum?
The MPs' dossier cautions against continued deliberations in government, saying that "further delay is itself a decision".
It is the strongest warning yet from Tory Brexiteers to the PM, who have largely been supportive, in public, of her efforts to negotiate Britain's exit from the EU.
Mr Rees-Mogg (pictured above) told BBC Radio 4's Today programme "we are not in the business of making threats".
If it came to a confidence vote in the prime minister over the issue, the Tory MP said it was "inconceivable" that he would vote against her.
Downing Street sources denied the document was an ultimatum, calling it part of the policy-making process.
What does the EU think about the customs partnership idea?
Brexit Secretary David Davis said on Tuesday that Brussels was "pushing back" against both proposals.
The EU thinks the customs partnership proposal is very ambitious - to put it mildly - and has given the UK a list of questions about it, writes the BBC's Brussels Correspondent Adam Fleming.
What new burdens will be placed on customs officials in the EU27? How will the UK apply EU customs law if it's no longer in the club? How will the "track and trace" system work?
The warning from Brussels about the UK government's other option, a "highly streamlined" customs deal, is that it doesn't fully solve the problem of avoiding a hard border between Ireland and Northern Ireland, which they say is about more than just tariffs.
Hanging over it all is the issue of trust because the EU and UK are still arguing over 2bn euros (£1.76bn) of allegedly unpaid duties on Chinese shoes and textiles imported into Britain, and legal action looms.
The EU's negotiators wonder whether the other side is about to change tack on a major issue, and they suggest that the upcoming political deal about the shape of the future relationship may have to be very vague if it's to find approval from a divided British government, parliament and public.
What do the opposition parties say about it?
Labour wants the UK to form a customs union with the EU after Brexit and says the prime minister is "being held hostage by the extreme Brexiteers in her own party".
The party's shadow Brexit minister Paul Blomfield said: "Labour has been clear that the best way to protect jobs, the economy and avoid a hard border in Northern Ireland is by negotiating a new comprehensive UK-EU customs union after Brexit.
"However, the Tories appear more interested in issuing ultimatums and squabbling amongst themselves than acting in the national interest."
The Lib Dems, who back staying in the customs union and want a referendum on the final Brexit deal, said Mrs May was "kicking the can down the road in a desperate attempt to hold the widening fissures of the Tory party together - it cannot and will not work".
SNP MP Tommy Sheppard accused the Scottish Conservative MPs who were among the group of Brexiteers warning Mrs May about a customs partnership of being "British nationalists, who long for the return of days of Empire and for the time when the map of the world was mostly pink".