The National Audit Office has refused to approve the government's accounts on the tax credits system, saying that the level of fraud and error is "unacceptably high".

It is estimated that HM Revenue and Customs overpaid credits by £1.8bn in 2004/05, while underpaying other claimants by £556m.

And the watchdog said that the position for 2005/06 is likely to be similar.

It was the fourth year running that auditor general Sir John Bourn has qualified his opinion on tax credits because of the likely level of claimant error and fraud.

HMRC cannot recover all the overpayments and in 2005/06 was forced to write off £397m, with a further £409m provision for 'doubtful debts'.

The tax credits system has also been targeted by organised fraudsters and in 2005/06 HMRC prevented payments of £409m in respect of suspected organised fraud.

It has also identified incorrect payments made of £131m, including fraudulent claims made using stolen identities through the tax credits e-portal of £55m at the end of 2005.

"The first full results of the new tax credit scheme since its introduction in April 2003 show that the level of claimant error and fraud was unacceptably high," said Sir John.

"I have therefore once again qualified my audit opinion on the trust statement.

"HMRC must now use this baseline figure to continue to target future reductions in error and fraud.

"HMRC closed the tax credits e-portal because of a serious attack by organised criminals submitting false claims using stolen identities.

"It must ensure that the new system fully complies with established government standards on security."