Multi-millionaire Sudhir Choudhrie and his son Bhanu, well-known as major political donors to Deputy Prime Minister Nick Clegg's Liberal Democrat party, were arrested and questioned for several hours on Wednesday before being bailed without conditions.
A spokesperson for the duo said they "deny all wrongdoing and are cooperating fully with the investigation".
Britain's coalition partners Lib Dems are now under the spotlight over their close links with Choudhrie, known to friends as Bunny. He has given the party over 500,000 pounds since 2010 and over 1 million pounds since 2004.
The entrepreneur, who moved to the UK in 2002 and is now based at a 5-million pound apartment in London's posh Chelsea neighbourhood, had been on a list of nominations from Clegg's office to be a Lib Dem peer in the House of Lords, but his name mysteriously did not go forward in 2013.
His son Bhanu manages the family business, C&C Alpha Group, as its chief executive. The group runs hospitals and care homes across the UK among a string of other ventures, including real estate.
Personal links with the Choudhrie family are set to further embarrass the Lib Dems as it emerged that Clegg and his wife, Miriam, hosted their family charity Path to Success at Lancaster House, a UK government building, in 2011.
The Choudhries have regularly attended other events alongside Clegg and other senior Liberal Democrats, including Simon Hughes, the Lib Dem Justice Minister, who received a 60,000-pound donation from Choudhrie last year.
A Lib Dem spokesperson said the party was aware of the allegations but could not comment while the investigation is ongoing.
The SFO is probing whether Sudhir Choudhrie was an intermediary used by Rolls-Royce, two people familiar with the situation told the Financial Times newspaper.
According to some media reports, Indian authorities are believed to have recently dropped a separate investigation into Choudhrie as part of a probe into deals done by Italian consortium Finmeccanica. No charges were brought against him and he strongly denied all wrongdoing.