Kirill Serebrennikov was arrested in St. Petersburg on Tuesday. He was later charged with fraud, Interfax news agency reported, citing Russia's investigative committee.
The committee, which investigates high-profile crimes, said Serebrennikov is accused of embezzling more than $1.2 million of government funds between 2011 and 2014, by taking money allocated for a theatrical project.
The 47-year-old creative director of progressive theater Gogol Center in Moscow has denied wrongdoing.
Serebrennikov faces a hearing on Wednesday, where he will learn whether he will await trial in prison or under house arrest. Supporters plan to gather in protest outside the city center court at midday during that appearance.
Reaction within Russia's cultural community was swift and outraged, with many expressing fears of a clampdown.
Andrey Saveliev, a prominent director and longtime colleague and friend of Serebrennikov, told CNN that people felt Serebrennikov was targeted because of his ''inconvenient and ideologically nonconforming'' work.
"Perhaps, if his art did not cause such a stir every time and did not cause such a stormy reaction, what is happening now would not be interpreted as an act that presumably has political reasons behind it,'' Saveliev said.
Opposition news site Meduza published an open letter in support of the director
and condemning what it called a ''fabricated case," comparing his case and specific charges to that of dissidents who were persecuted during Soviet times.
Referring to the estimated 4 million people prosecuted for counter-revolutionary activities under Article 58 of the Soviet penal code, the editorial said: 'We know that the article on fraud is nothing better than the infamous Article 58, it is the same effective and universal tool for punishing people, except no one gets shot.''
One of Russia's most famous actresses, Liya Akhedzhakova, wrote on her social media account that the situation was reminiscent of the dark days of those purges, likening Serebrennikov to theater director Vsevolod Meyerhold, victim of Soviet dictator Joseph Stalin's purges.
Meyerhold was executed in 1940 after his experimental works were deemed anti-Soviet.
Investigative committee spokesperson Svetlana Petrenko said authorities have substantial evidence against Serebrennikov, saying ''his guilt in committing large-scale fraud is confirmed by the testimonies of witnesses, the results of investigative activity, financial documents obtained during the investigation and other evidence.''
Long considered one of Russia's most gifted talents, Serebrennikov is known for his controversial productions and anti-censorship stance.
He was also an outspoken supporter of artistic freedom in Russia even as socially conservative forces gathered strength.
In 2015, he defended a colleague whose opera was canceled and investigated for desecrating religious objects, criticizing conservatives in an open letter.
''Theater is a territory of freedom. If they wish to avoid being annoyed, offended, embarrassed or angry, let them sit in churches,'' Serebrennikov wrote.
His film "The Student," which won an award at the Cannes festival last year, explored the blurring of the lines between religion and state through a portrait of the growing fanaticism of a schoolboy.
Last month the Bolshoi Theatre canceled his ballet about dancer Rudolf Nureyev days before it opened. The legendary institution denied at the time that the reason was the portrayal of Nureyev's gay relationships and battle with AIDS, both controversial subjects in the biography of the Russian cultural icon and contemporary Russia.
On Tuesday, the director of the Bolshoi, Vladimir Urin, said Serebrennikov was a ''great artist'' and ''very gifted and talented.''
In May, Urin was one of a group of cultural figures who signed a letter in support of Serebrennikov, which was then delivered personally to Russian President Vladimir Putin as he was awarding one of them with a state medal.
Serebrennikov was initially questioned in May as a witness in an embezzlement case, according to state news agency Tass.
He was released at the time but two colleagues were remanded in custody. One has reportedly been charged and testified against Serebrennikov.