The arrest, made earlier this year but made public only this weekend, prompted Prime Minister Rishi Sunak to warn Premier Li Qiang in person about Chinese "interference" in democracy.
But it also provoked a strong denial in Beijing, which has reacted angrily to previous criticism of its human rights record against the Uyghur minority and the erosion of civil rights in Hong Kong.
Updating parliament about his visit to the G20 summit in India, Sunak said MPs were "rightly appalled about reports of espionage in this building".
"I was emphatic with Premier Li that actions which seek to undermine British democracy are completely unacceptable and will never be tolerated," he added of confronting Li on Sunday on the sidelines of New Delhi meeting.
The spying claims, first disclosed in The Sunday Times, are putting pressure on Sunak's government to toughen its policy on China as it seeks greater engagement with the Asian superpower.
When he was running for the Conservative party leadership last year, Sunak called China the "number one threat" to domestic and global security.
But in power he has rowed back on that tough rhetoric, instead characterising China's rise as a strategic challenge and pushing for pragmatic engagement to tackle issues such as climate change.
- 'Pure fabrication' -
Iain Duncan Smith, a former Tory leader and China hawk who has been sanctioned by Beijing, called that approach "weak".
"The result is that China is penetrating all our institutions from universities to parliament," he said.
The suspect, said to be in his 20s, was arrested at his home in Edinburgh in March, along with another man in his 30s.
Both were detained on suspicion of offences under the Official Secrets Act and have been released on bail until October, pending further investigations.
If proven, it would represent one of the most serious breaches of security involving another state at the UK's parliament.
Britain's leaders remained tight-lipped Monday on details of the case, citing the ongoing investigation.
However, Chinese foreign ministry spokeswoman Mao Ning told a Beijing news conference that "the so-called claim that China is conducting espionage activities against the UK is pure fabrication. China resolutely opposes this."
"We urge the UK to stop spreading disinformation and stop its anti-China political manipulation and malicious slander," Mao added.
The younger man who was detained has not been named by UK authorities. He has denied any involvement in espionage in a statement released by his lawyers.
"I feel forced to respond to the media accusations that I am a 'Chinese spy'. It is wrong that I should be obliged to make any form of public comment on the misreporting that has taken place," he said.
"However, given what has been reported, it is vital that it is known that I am completely innocent."
- Growing concerns -
The accused added: "I have spent my career to date trying to educate others about the challenge and threats presented by the Chinese Communist Party.
"To do what has been claimed against me in extravagant news reporting would be against everything I stand for."
Concerns over China have been growing in the UK in recent years, even as London looks to the Indo-Pacific region for new business and trade opportunities after leaving the European Union.
Foreign Secretary James Cleverly visited Beijing last month, after a UK parliamentary committee called China "a threat".
"The behaviour of the Chinese Communist Party is currently characterised by increased aggression" towards Britain, the intelligence and security committee wrote.
British security services last year warned MPs that a suspected Chinese spy had engaged in "political interference activities".
The woman, a London-based solicitor, reportedly donated �200,000 ($275,000) to a leading opposition Labour MP and hundreds of thousands of pounds to his party.
Britain in 2020 ordered the phased removal of Chinese telecoms company Huawei from its 5G network -- including national intelligence -- after pressure from backbenchers led by Duncan Smith, who called the firm an arm of the Communist Party.
In March, Chinese-owned video app TikTok was banned on British government devices over fears user data could be used or abused by Chinese officials.
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