A document made public in Paris is said to show that the French leader and the former Libyan dictator made an illegal financial deal.
Written in Arabic and signed by Mussa Kussa, Gaddafi's intelligence chief, in 2006, it refers to an "agreement in principle to support the campaign for the candidate for the presidential elections, Nicolas Sarkozy, for a sum equivalent to €50m".
A bundle of incriminating evidence was originally leaked by senior members of Libya's National Transitional Council to French investigative news site Mediapart.
A governmental briefing note among papers sent to Mediapart points to numerous visits to Libya by Sarkozy and his colleagues which were aimed at securing funding.
One, said to have taken place on October 6, 2005, led to "campaign finance to NS" being "all paid" - assumed to be a reference to Sakozy.
At the time, Sarkozy was an ambitious interior minister who was raising money for his presidential election campaign, even though taking cash from a notorious tyrant would have broken political financing laws.
Mediapart claims that the €50m referred to in the note was laundered through accounts including a Swiss one opened in the name of the sister of Jean-Francois Cope, the leader of Sarkozy's UMP party, who are now called the Republicans.
The money was then allegedly distributed through an arms dealer called Ziad Takieddine, who was acting as a middle man between Arab despots and French politicians.
The news follow claims last year by Gaddafi's son, Saif-Al Islam Gaddafi, that Libya had financed Sarkozy's election.
Saif-Al Islam, who is now being held in Libya following the toppling of his father's regime, said: "Sarkozy must first give back the money he took from Libya to finance his electoral campaign. We funded it."
Eyebrows were first raised when Gaddafi was honoured with a state visit to Paris in late 2007.
He was referred to as the 'Brother Leader' by the French president, and allowed to pitch his tent next to the Elysee Palace.
The apparently incriminating evidence - which will now be passed to French police - emerged through an investigation into Takieddine's activities. The arms dealer's doctor, Didier Grosskopf, says he witnessed negotiations about funding.
As France's head of state, Sarkozy could not be prosecuted while in office, but fraud squad officers raided his Paris home within days of him losing the 2012 presidential elections.
Sarkozy turned on his friend Gaddafi at the beginning of the Arab Spring in 2011.
French jets were the first to attack Gaddafi's tanks in a brutal military campaign which ended with the Libyan leader being murdered.
Since losing the election in 2012 to his socialist rival Francois Hollande, Sarkozy has been living in Paris with this third wife, former supermodel and pop singer Carla Bruni, 50.
He has tried to make comebacks to power, but all have failed.
A judicial source in Nanterre said: "Mr Sarkozy can be held in custody for up to 48 hours. His period in custody started on Tuesday morning."
