The EU suspect the money of being misused by the Hamas movement which took control in June.
The power station shutdown, severely exacerbating an existing power shortage, is expected to affect Gaza's water supply, hospitals and sewage.
The station normally supplies a quarter of Gaza's electricity needs, but on Sunday the EU halted its monthly payment of 6.5 million for the fuel supplied by Israel's Dor Alon company.
David Kriss, a spokesman for the European Commission in Tel Aviv, said the decision was made for "security reasons", but also came after officials received information that Hamas planned to levy taxes on electricity bills in the Gaza Strip.
"We do not want revenues to accrue to a Hamas government that the European Union does not recognise," Mr Kriss said.
He added: "This is not a political move, as far as we are concerned. We are not in the business of mixing politics with the suffering of the Palestinian people."
Riyadh Malki, for the Ramallah government, saidHamas is to blame for the shutdown, because after its armed takeover of the Strip in June it also took over Gaza's electric company "and started collecting the revenues and taking them to its pocket".
Hamas, meanwhile, blames the Ramallah government for the cut-off of European funding, saying it comes as part of an ongoing attempt to undermine the Gaza government of Ismail Haniya, the Hamas leader.