Her Majesty's Revenue & Customs (HMRC) department has threatened Electronic Data Systems with legal action to recoup some of the monies lost as a result of a troubled tax credit management software system.

The department is threatening a lawsuit to recover part of an estimated £2bn in overpayments to taxpayers that were caused in part by technical glitches in a credit system both designed and implemented by EDS.

The system was built to guarantee that accurate credits were awarded to families who have children or fall below certain income levels.

Citing the pending litigation HMRC declined to disclose EDS's specific role in building or supporting the system, or the amount it would seek to recover.

Most of the errors were the result of procedural errors, according to the department. The remaining overpayments, which it is seeking to recover from EDS, were the result of processing and technical glitches. The amount of those particular overpayments wasn't disclosed.

Overall, the agency has said that about £52m has been deemed unrecoverable.

Texas-based EDS implemented the system, but after its support contract expired in June 2004, EDS rival Capgemini was hired by HMRC to take over.

"HMRC now has a new IT partner, the system is working well, and discussions are ongoing with EDS about compensation for past failures," HMRC said in a statement. "Court proceedings will begin if and when those discussions do not satisfactorily resolve the dispute."

Citing potential litigation, HMRC representatives declined to go into the specifics of the system or the technical problems involved.

A July 2003 House of Commons Treasury Committee report, however, said the EDS-built credit-processing system suffered performance problems as it took feeds from other systems. In addition, the committee report said that the IT staff found response times to be inordinately slow, which caused the system to be brought down several times a day.

An EDS spokesman declined to comment on any specifics of the situation. "These discussions continue, and we're putting our best resources on them with the aim of making sure we get to the point where there is an agreement that's mutually acceptable around the tax credits issue," he said.

EDS's reputation could be harmed if the agency proceeds with the lawsuit, said John O'Brien, an analyst at London-based research firm Ovum Ltd. In a note published on 21 June, he said EDS has been rebuilding its reputation in the UK public sector since losing the tax agency's contract to Capgemini last year.

The company got a big boost in rehabilitating its image when it won a IT services revamp contract with the Ministry of Defence last March.

However, O'Brien noted that "this ghost of EDS's past just won't go away" and that the company must be careful about how it handles the situation.