Fraud and errors on VAT cost taxpayers an estimated £11.9 billion in the last financial year, according to parliament's spending watchdog.

A report published by the National Audit Office said the amount that HM Customs and Excise failed to collect was up from £10.6 billion in the year 2001/02.

But the NAO said there were signs that Customs was beginning to narrow that gap between what it should collect and its actual income.

One of the most serious types of VAT fraud, so-called "missing trader fraud", appeared to be declining, added the watchdog.

Customs estimate that in 2001/02 between 125,000 and 180,000 traders operating in the shadow economy had not registered for VAT resulting in losses of £400 million to £500 million. 

But cooperation with the Inland Revenue and the Department for Work and Pensions saw Customs detect almost 4,000 traders who should have been registered VAT.

The action resulted in additional revenue of £65 million.

Penalties fall

Meanwhile, the number of cases where penalties have been imposed on those evading VAT has fallen from 898 in 1997/98 to 276 cases in 2002/03.

But the report said this was the result of Customs’ targeting more complex and larger value cases.

“Each year the public coffers are cheated of billions of pounds as a result of VAT lost through fraud and error. This is money which could be used to improve public services," said NAO chief Sir John Bourn.

"Customs are working hard to reduce these losses, through new measures to improve compliance by traders and to detect and stop fraud.

"They have achieved some progress, for example on VAT missing trader fraud, but success will ultimately turn upon whether they can secure a sustained reduction in the level of losses."