Mariano Valverde, manager of the Aquópolis water park in Villanueva de la Cañada in Madrid, was taken into custody on Thursday by the environmental protection unit of Spain's Civil Guard police force.
He is suspected of fraudulently using 400,000 cubic metres of water over five years — a fraud worth up to €500,000 ($666,000).
If found guilty, he could face heavy fines.
Valverde claimed to have been using water from underground wells managed by the authority which oversees the waters of the river Tajo.
But police now believe the park was actually siphoning water from the key Canal de Isabel II which provides water to the Community of Madrid.
The park has a water contract with Canal de Isabel II but hasn't used any of its water since 2008.
The Tajo river authorities, meanwhile, say they have never signed a contract with the water park.
Parques Reunidos, the company which operates the popular park, said in July that it had complied with all water laws.
The company operates 11 parks across Europe, with seven of those in Spain.