The top civil servant at the Scottish Government's Justice Department was warned two years ago that the new Scottish Police Services Authority would incur up to £5m a year in VAT.

The revelation comes just a day after The Herald revealed a major blunder by civil servants and the previous administration means the authority, which was set up to create cost savings and centralise procurement, will have to pay VAT.

Officials only contacted Her Majesty's Revenue and Customs (HMRC) with their full case for exemption some six weeks ago, despite the fact the planning for the body started more than two years ago and the authority became active in April this year.

Andrew Keddie, former convener of Fife's police board and a member of the Common Police Services Committee, which preceded the authority, warned Robert Gordon, head of the Justice Department, in late 2005 that the creation of the SPSA would be too costly because it would not be VAT exempt.

Mr Gordon, one of the senior civil servants heavily criticised following the Holyrood building fiasco, allegedly told the committee that the problem would be resolved.

As the chair of the committee, members claim he also rejected an alternative proposal by the chief constables and conveners which would have created an alternative VAT exempt body. In October 2005, the Association of Chief Police Officers in Scotland (Acpos) also expressed "serious misgivings" to the parliamentary Justice Committee about the structure and governance proposed for the SPSA.

"I told the Common Police Services Committee more than two years ago that if they made SPSA a public body it would cost an extra £3-5m a year in VAT," said Mr Keddie. "This was debated more than once.

"We also pointed out that creating a new body with a chief executive earning more than £106,000 a year would add to costs. Sir Willie Rae, who was then the chief constable of Strathclyde, also warned them about the VAT, but they would not listen. We told Robert Gordon this would impact on frontline services."

Police board conveners and chief constables also warned that the legislation to establish the new authority was too rushed and removed too much public accountability.

Traditionally, policing works under a tripartite arrangement between chief constables, the Scottish Government and local authority boards made up of elected members. The SPSA is accountable to ministers and its board, which is chosen by ministers.

"This was discussed at the end of 2005 and in early 2006," said Jean McFadden, former convener of the Strathclyde police board and an occasional member of the committee. Now the chickens are coming home to roost. Robert Gordon seemed to think it was something which would solve itself. The main issue is that there was no good argument for making this a public body other than the fact it would give civil servants greater control of policing."

A spokeswoman for the Scottish Government said: "Arrangements for the establishment of the Scottish Police Services Auth-ority were put in place under the last administration. Contrary to the impression given, officials in Scotland were well aware of the VAT issue and were in contact with HMRC last year before SPSA even commenced operations - so it is simply wrong to suggest nothing was done about it.

"SPSA was set up as an NDPB non-departmental public body which means it does not share the VAT status of police authorities. However, in providing services such as ICT (information and communications technology) and forensic services to Scottish police forces we believe that SPSA is conducting business activities with police forces which would allow it to reclaim VAT. SPSA has put a detailed and robust case to HMRC which is currently being considered by them.

"We hope there will be a satisfactory resolution of SPSA's VAT position but we must not lose sight of the wider issue."