The Serious Fraud Office (SFO) was fined more than half a million pounds for owing HMRC £4m in VAT.

The fraud watchdog used to reclaim VAT on legal fees and some specialist staff.

After a new chief financial officer reviewed its VAT policy, the SFO decided to stop re-claiming VAT on external counsel fees in December 2012.

In 2013, the SFO, which investigates the most serious and complex cases of fraud, bribery and corruption, asked HMRC to confirm how it should account for recovered VAT on outsourced services.

“These discussions, coupled with an HMRC assessment which took place in October 2013, led to the SFO having a liability for reclaimed VAT in previous years… amounting to a total of £4,635k [£4.6m] including a penalty of £564k, interest of £104k, accrued tax of £798k and outstanding tax of £3,169k,” the SFO said in its annual report for 2013-2014.

It shows that the £660,000 in penalties and interest were accounted for as programme costs under civil litigation - sums that one might assume should be devoted to pursuing wrongdoers.

The annual report indicates that £1.9m of the VAT repayment was accounted for as fees for legal counsel, £580,000 was included as other staff costs; and £17,000 under IT costs.

The VAT bill was partly responsible for the SFO net operating costs rising from £38.1m in 2012-13 to £51.7m. Costs associated three “blockbuster” investigations were also to blame along with a £200m damages claim from businessman Vincent Tchenguiz for malicious prosecution, trespass, false imprisonment and misfeasance in 2013.

The investigator frequently comes under fire for ineptitude and is castigated by Private Eye as the “Serious Farce Office”. In February, the Financial Times reported that SFO director David Green QC had asked the Treasury for £19m in exceptional funding, equivalent to more than half its overall annual budget.

But Green struck an optimistic note in his introduction to the 2013-14 annual report. “We have had eight prosecutions of 18 defendants either concluded or in progress. The conviction rate by defendant was 85%. All of our cases are high profile and therefore high risk.

“With our recalibrated caseload, expanded intelligence capability, the building of cooperation with partners and stakeholders foreign and domestic, blockbuster funding for exceptionally large cases and the recruitment and retention of high quality staff, I am confident that we have in place the building blocks necessary for the success of the SFO.”