The UK tax authority is seeking to recoup more than £4 million from the watchdog that scrutinises the spending of Scottish public authorities.
HMRC wants to claw back £4.1 million of VAT rebates it believes were wrongly paid to Audit Scotland since 2006.
The Scotsman understands that the cash relates to work carried out by Audit Scotland on behalf of the Accounts Commission, which involves auditing Scotland’s local authorities.
Audit Scotland sub-contracts some of that work to accountancy firms, who charge the watchdog a fee which includes VAT. In the past, Audit Scotland had worked on the basis that it could recover VAT it has been charged for this work. HMRC has challenged this arrangement.
The HMRC will also hit Audit Scotland with interest and penalties for a second VAT debt of about £160,000, liable on income earned by contracting out staff to other public bodies. The debt could see local authorities’ fees for audit work increased by around 5 per cent.
The full extent of the debt was revealed at a meeting of the Scottish Commission for Public Audit (SCPA) at Holyrood yesterday. The SCPA, which scrutinises Audit Scotland, comprises five MSPs under the convenership of SNP MSP Colin Beattie.
Appearing before the SCPA, the Auditor General for Scotland, Caroline Gardner, said: “There are two VAT issues under discussion between us and HMRC. The first relates to registration of Audit Scotland for business activities, which has been a matter of discussion over the last couple of years.
“That liability of £160,000 is crystallising and we are pleased to say that that issue is closed down, and we are simply waiting for confirmation of the charges that HMRC may apply within the £160,000.”
Assistant Auditor General Russell Frith said: “We would not expect the penalties to exceed around 15 per cent and we have covered that within the provisions already made.”
Ms Gardner added: “Unfortunately, however, HMRC have now raised a new issue that relates to the tax status of the Accounts Commission.
“When Audit Scotland was formed in 2000, it merged the former Accounts Commission for Scotland with the National Audit Office’s activities in Scotland to form the new body. Before the merger, the Accounts Commission had ‘Section 33’ status, which enabled it to reclaim input tax on the audit fees charged to local government.
“We discussed with HMRC’s predecessor body about continuing that status, since the Accounts Commission’s responsibilities were unchanged.”
Since 2006, Audit Scotland has been recovering the VAT on behalf of the Accounts Commission, but HMRC has now challenged this and suggested tax recovered during that period should be repaid.
Ms Gardner said: “The scale of the past liability is more than £4m. The amount we have reclaimed over that period is between £400,000 and £500,000 a year. We have just been through a four-year budget strategy in which we have reduced the cost of audit by more than 20 per cent. I struggle to see how we could reduce our costs by anything approaching that amount.
“We would continue to apply that pressure, but the options would be to ask the SCPA for funding or look at recovering it through local government fees, neither of which is palatable.”
In a letter to the SPCA, Ms Gardner said: “If the agreement is not continued in future, the cost of local government audit would rise by 4-5 per cent. We believe HMRC have some fundamental misunderstandings about the current arrangements and have responded robustly.”