Gursewak Singh alias Babla, 51 was allegedly trying to collect funds to revive the KCF and was in touch with gangs in Delhi with a plan to commit bank robberies, they added.
He was arrested yesterday from National Highway 8 at Mahipalpur and a "sophisticated" pistol, loaded with four cartridges, was seized from his possession, police said.
Gursewak was an associate of Jarnail Singh Bhindranwale who was killed during the army's Operation Blue Star in 1984.
He was planning to revive the banned outfit on instructions of KCF chief Paramjeet Singh Panjwad, who is currently in Pakistan, and was in touch with Jagtaar Singh Hawara and other terrorists lodged in Indian jails, said Joint Commissioner of Police (Crime) Praveer Ranjan.
Gursewak had twice managed to run away from the custody of police, once in Delhi and once in Rajasthan, he added.
In the 1980s, Gursewak was involved in over 50 cases of terrorist activities, murders of police officials and informers, bank and police station dacoities etc. in Punjab, Delhi, Rajasthan and Madhya Pradesh, said Joint Commissioner Ranjan, adding that his elder brother Swaran Singh was a member of the terrorist group run by Bhindranwale.
Terrorism was at its peak in Punjab in the 80s when Gursewak came in contact with Bhindranwale's nephew Darshan Singh. He joined the terrorist group in 1982.
He was arrested in 1984, following an encounter with Ludhiana Police, while the other members of his group were arrested by the army post Operation Blue Star.
In June 1984, Bhindranwale was killed and most of his associates, aided by Pakistani intelligence agency ISI, fled to that country, said Mr Ranjan.
Subsequently, several militant outfits such as the KCF, Babbar Khalsa, Bhindranwale Tiger Force etc. were revived on instructions of the ISI, he said, adding that Gursewak then joined the KCF faction headed by Manveer Singh Chehdu.
This was the period when he and his associates were allegedly involved in dozens of murders of suspected informers of Indian security agencies as well as bank dacoities in Punjab, Delhi and Rajasthan.
In 1986, Gursewak and his associates allegedly attacked the Jalandhar residence of Julio Ribeiro, ex-DGP, Punjab, to take revenge for police action against terrorist groups in the state.