A suspected scam involving the trading of carbon credits could cost businesses that unwittingly took part millions of pounds in legal fees and penalties.

The scam, first uncovered by HM Revenue & Customs (HMRC) in January, culminated in the arrest of seven people this month. It allegedly involves an elaborate scheme known as a carousel fraud, where goods are imported into Britain Vat-free and then sold on to a series of companies, each of which is liable to pay the standard rate of Vat on the purchase.

“There is a real risk that innocent businesses have been caught up in a chain that involves the people arrested,” said James Hurst of Grant Thornton, the auditing firm. “Any company may now be subject to investigation.”

Carbon credits allow firms to emit carbon dioxide and are traded between companies and financial institutions. Businesses buy them either as a way to offset the emissions from their operations or to comply with pollution caps set by the European Emissions Trading Scheme (ETS).

The ETS was created out of the 1997 Kyoto treaty as a way to curb emissions of climate-warming gases. It specifically limits the emissions of high energy consuming industries such as oil and manufacturing. Companies that emit more than the limit they have been set can avoid penalties by purchasing spare “allowances” from companies that have stayed within their limits.

The EU allowances market represents about 75% of the total carbon trading market. In the first half of the year, €8 billion (£7 billion) worth of allowances were traded, according to Point Carbon, a consultancy. Roughly a quarter of these deals were done in the spot market.

So far, HMRC has valued the scam at £38m. But tax-fraud experts suspect this is only the tip of the iceberg. Previous carousel fraud rings involving mobile phones and computer chips are estimated to have cost the exchequer as much as £8 billion.

The potential liability for businesses is significant because the government has the right to reclaim the Vat on any carbon trade it deems suspicious.

Exactly how much is at stake is difficult to quantify, as millions of carbon trades are made each day through various exchanges. The average value of a single carbon trade is £50,000. The Vat rate was 17.5% until the chancellor reduced it to 15% for this year.

“The law gives HMRC the right to audit any businesses that have purchased carbon credits and block their ability to recover Vat if they cannot prove that they took ‘reasonable care’ in ensuring they made the purchase from a credible company,” said Sandy Nicholson of KPMG, the accountants.

HMRC can also penalise companies retroactively for three years. Penalties can be 100% of the Vat avoided.

“The law means that any business could be treated as guilty until proven innocent,” said Nicholson.

The law also leaves open a big question as to what qualifies as “reasonable care”. As carbon trading is only about five years old, there are no hard and fast rules governing best practice. HMRC’s anti-fraud squad says businesses should follow the common commercial practices of “knowing your customer”, “knowing your supplier” and “knowing your products”.

However, business groups said this was not good enough because at present anyone can register as a carbon trader.

“Even though the government has removed Vat from carbon trades, that doesn’t mean criminals won’t find another way of committing fraud. Businesses need specific guidance on carbon trading to ensure that they are protected and to reduce their exposure to any criminal activity,” said the Engineering Employers’ Federation.

Tessa Laws, a partner at Rosenblatt, the law firm, said that until a carbon trading code of conduct is in place, the best advice to businesses is simply “buyer beware”.

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