Governors claim council officers had known about the arrangement for years and school governor Darren Mayor resigned - calling on other governor/councillors to follow suit.
A county council report found 187 pupils have benefitted from subsidised transport during this academic year. Of those, 38 are from other parts of north Powys while 149 go to Llanfyllin from the Oswestry area.
The council says this breaks finance regulations because the school budget is intended for education, not transport. Funding to transport pupils from another catchment should be provided by the PTA or by parents themselves, the report said.
The dual-stream school - which has more than 80% of pupils in the English stream and fewer than 20% in the Welsh stream - has more than 800 students on its register.
In a letter to the leader of the council Darren Mayor wrote: "At no point has the governing body ever hidden the use of its delegated budget and each year this transparency has been evident when budgets have been approved by the education department."
The cabinet said the school must comply with the rules by September.
The Cabinet is meeting this afternoon to consider a report recommending the school repays the money.
The council investigated the school's accounts after being contacted by the Wales Audit Office and found it had spent the money during a five-year period subsiding transport to pupils from outside catchment.