A major blunder by civil servants and ministers means a controversial authority set up to make savings across the police service is facing a multi-million pound VAT bill.

The embarrassing oversight has left the Scottish Police Services Authority without VAT exemption. It would incur a £5m annual charge if it goes ahead with plans to centralise purchasing for all eight forces.

The Treasury has written to the Scottish Government to explain that the SPSA, established to ensure efficiency savings and centralise procurement, has to pay 17.5% VAT on all purchases.

Sources claim the agency contacted Her Majesty's Revenue and Customs only six weeks ago to ask for the special VAT exemption currently afforded to police forces, despite the fact it became fully operational in April.

The news is expected to prove awkward for ministers who have already had to water down a manifesto pledge to introduce 1000 new police officers. But most of the responsibility will have to be taken by the previous administration at Holyrood which created the body and failed to clarify its tax status last year.

Established under the Police, Public Order and Criminal Justice (Scotland) Act 2006, the SPSA was set up to produce efficiency savings by centralising the provision and procurement of training, IT and forensic services.

It also maintains the Scottish Crime and Drug Enforcement Agency (SCDEA), the country's leading crime fighting unit.

Questions have already been raised about the interpretation of the legislation following the decision of Graeme Pearson, the former head of the SCDEA, to take early retirement after complaints by politicians that the agency's autonomy had been compromised by the new authority.

"The Treasury has now written to officials to explain that the SPSA is not VAT exempt," said one source. "I think the Justice Secretary will be greatly embarrassed and very angry that he has been exposed by what is a civil service blunder of enormous proportions.

"It could cost the police service capital budgets anywhere up to £5m per year, set against a background of what is in real terms a very tight spending review settlement.

"It means that using the SPSA for police procurement is not a viable option as any efficiency saving within a procurement would need to be in excess of 17.5% before there was any saving or benefit."

Talks are continuing with Revenue officials to see if the authority could obtain special status to avoid VAT but it is unusual for non-departmental public bodies to have it granted. Bodies such as the Serious Organised Crime Agency have already been turned down.

Under Section 33 of the 1994 VAT Act, local authorities and therefore police boards do not pay VAT on most purchases.

David Mulhern, chief executive of the SPSA, said: "The VAT issue is something we are well aware of - in fact we have been in active dialogue with Revenue and Customs for quite some time to bring resolution.

"Constructive discussions are ongoing and I am confident that we are ready to deliver an efficient and effective service to Scottish policing that will realise a single approach to delivery of ICT (information and communication technology) for the first time.

"SPSA was set up to deliver efficiencies for the Scottish police service. That is, and will always be, our priority".

A spokeswoman for SPSA said: "We have been working on this with our advisers and the Scottish Government for quite some time on our options with regard to VAT."

A spokesman for HMRC said: "Talks are ongoing and we are looking at the activities which SPSA is dealing with. The big problem for new public agencies is that they don't have section 33 status."

Opposition politicians said the situation needed to be resolved for the SPSA to fulfil its purpose.

Bill Aitken, the Tory justice spokesman, said: "I find this both incredible and disturbing. Surely someone would have had the nous to check the position long before now. The impact on the capital budget will obviously be severe and there could also be revenue consequences.

"Clearly they need to make appropriate applications to the Treasury for exemption or the authorities' raison d'etre of making savings is simply blown out of the water."

Pauline McNeill, Labour's justice spokeswoman, said: "It seems to me that this is so crucial to the operation of the SPSA that it should have been resolved before it was set up. We should not be finding this out now."

Margaret Smith, the Lib- Dem justice spokeswoman, said: "Centralised procurement for police forces was a sensible course of action, designed to save individual police forces time and money. The individual forces are VAT exempt, so it's common sense that the body now procuring resources for the forces should also be VAT exempt.

"The Scottish Government must make representations to the Westminster Government to resolve this situation."