THE Scottish Government faces a penalty of up to £190m because of irregularities in spending hundreds of millions in Euro funds which have stretched back six years, the Herald on Sunday can reveal.

The potential penalties arise from the suspension by the European Commission (EC) of millions of pounds in payments earmarked for Scotland under both the European Social Fund (ESF) and the European Regional Development Fund (ERDF).

According to financial details seen by the Herald on Sunday, in the two years up to April alone the Scottish Government has had to put aside a total of £45.5m of taxpayers' money as a 'contingent liability' over the suspensions as it has had to pay out on projects and was unable to make claims from the Euro funds.

The Euro funds suspension began 15 months ago.

And a freeze on funding has been in place for two years, even though ministers expected it would be resolved in the summer of 2019.

The Scottish Government said over the weekend that the suspensions had been partly lifted.

Scotland was allocated over £800m over the seven years to 2020 from the Euro funds which require national co-financing from either public or private sources. The money was to be used to improve digital connectivity, increase employment opportunities, make Scottish businesses more competitive, tackle poverty and inequality, improve transport links and environmental protection and build a sustainable, low-carbon Scotland.

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The nation was also allowed €465 million (£404m) from the ESF which provides cash for projects aimed at creating and supporting jobs, including training to unemployed people with the aim of alleviating poverty.

And there was a further €477m (£415m) under the ERDF which aims to transfer money from richer regions, and invest it in the infrastructure and services of underdeveloped regions.

The Highlands and Islands have been one of the UK's top three per capita beneficiaries of the latest seven year cycle of structural funding - with only Cornwall and west Wales and the valleys getting a greater share.

There are over 200 operations funded through the current structural funding programme and has included funding for mobile masts to extend 4G coverage in the Highland & Islands, low carbon energy and electric vehicle projects and funding to colleges and universities to provide upskilling in specific sectors, including food & drink, life sciences and renewable energy.

Ministers have been warned by auditors that with funds having been suspended, the EC can impose a maximum penalty of up to 25 per cent of the programme - which amounts to around £190m.

According to official audit details the EC had concerns about spending being "valid" after "weaknesses in the nature and extent of verification checks performed by the Scottish Government" were identified by EC officials.

With the ESF, the application of a 40 per cent flat rate in grant claims for staff costs was seen as a "misinterpretation" of EC regulations and the related spending had to be withdrawn.

But payments continued and ministers agreed to resume reimubursement themselves, according to an official audit document.

It says the problems stem from issues which surfaced over six years ago and in August, 2015 the the EC suspended more than £45m earmarked for Scotland under the social fund over "irregularities" in spending.

Some £41.4m was due to go to projects in the Lowlands and Uplands and about £4.8m for the Highlands and Islands.

At that time ministers blamed "technical issues" and said they were working to comply with EU regulations.

The EU said then that the Scottish Government had done too little to resolve concerns about its accounting, seven months after the problems were first reported.

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The EC said that issues that arose in December, 2014, related to problems in the "management and control system".

A control report from 2014 found "irregularities concerning expenditure in several operations".

After several months of discussion, the EC said there was "insufficient assurance" that enough was being done to rectify the problems and suspended payments.

Funds suspended dated back to a previous programming period 2007-2013.

The Scottish government said the problems arose due to some public bodies failing to comply with audit obligations.

Ministers work with partners such as the Scottish Funding Council, Skills Development Scotland, Scottish Enterprise, Zero Waste Scotland, Transport Scotland, Scottish Natural Heritage, Glasgow City Council and Highlands and Islands Enterprise to convert the ESF & ERDF budgets allocated to them into projects.

It said some projects had been "unable to adequately account for all the funding they received and spent" which led to the "interruptions and suspensions".

It said payments were not being frozen and projects had already been paid by the Scottish government.

But the Commission would not repay the Scottish government for funds paid out in 2014 until auditors were satisfied that all funds could be accounted for.

By September, 2016, the Scottish Government was told that the suspensions were lifted. But that involved cutting its declared spending, used to calculate what it gets from the EU by €36 million (£30m).

Audit details at the time have revealed that ministers made a provision of £14 million to reflect a "permanent loss of grant to the Scottish Government which it cannot now recover".

At that time ministers were warned by their auditors of the "risks relating to the management and control of European funding which, for the foreseeable future, will continue to be an important income-stream for the Scottish Government".

By the following year the net cost to the Scottish Government was £21 million subject to final EC checks.

Closure of the 2007-13 Euro funding programme also revealed that the Scottish Government overpaid project sponsors a total of £16m as a result of errors identified by an internal audit.

Auditors said at the time that there remained "uncertainty" over whether the money would be recovered.

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But in February 2019, the EC notified the Scottish Government that the ESF had been placed in 'pre-suspension' as a result of "serious deficiencies" in the management and control system 'mirroring' previous problems.

The EC, which gave ministers nine months to resolve the issues, again stopped making payments, while the Scottish Government could not make claims, until the irregularities were identified and resolved.

Auditors then warned ministers that they would face a financial penalty if the programme was placed in full suspension.

By June it was estimated that some £9.6m could not be reclaimed from the EU but ministers expressed "confidence" that the issues would be cleared in a few weeks.

But in November 2019, the European Commission placed the ESF programme in full suspension after the Scottish Government were unable to resolve the issues.

And in January 2020, the EC also placed the ERDF programme into suspension.

According to audit details the Scottish Government has been trying to resolve the issues and hoped all suspensions would be lifted at the end of next month.

The Scottish Government says that the ERDF fund suspension has been lifted and it is now submitting claims to the EC. But suspensions remain over the ESF fund.

The European Commission has not commented.

"We are continuing to work towards lifting the European Social Fund suspension and have until December 2023 for payment claims to be submitted," a Scottish Government spokesman said.

"These two funds were suspended by the EC due to audit issues that arose in 2015 and 2016 and identified in 2017 and 2018. The EC identified a number of issues with the management verification process and the programmes being delivered by lead partners. The Scottish Government has subsequently implemented an extensive programme of improvements to ensure full compliance with all EC regulations.

"The suspensions only affect how the Scottish Government is reimbursed and we have paid all verified claims received from lead partners delivering projects."

To access the full amount of EU funds available, projects must be created and allocated a budget and money must be spent and claimed back within a set timescale.

According to European Commission details seen by the Herald on Sunday by September, indicate just 17% of the ERDF funding alone in Scotland had so far been spent.

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Source: European Commission

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The EU requires that structural funds’ managing authorities like the Scottish Government, publish a financing plan which sets out how much money will be committed to projects in each year.

There is then three years to spend this money. If after three years the money is not spent and claimed, the money is lost in a procedure called "decommitment".

According to official documents seen by the Herald on Sunday, at the end of 2017, the Scottish programmes 'lost' a total of €73m (£63m) in 2017 and 2018 alone.

The Scottish Government claims most Euro funding money from the European Commission “in arrears”.

To prevent fraud, the EU’s rules include a mechanism to “interrupt” the payment deadline for a claim if additional evidence is needed to verify the expenditure or where there are significant deficiencies in management systems.

This interruption can last for six months, or up to nine months if the parties agree.

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Penalties over Euro fund irregularities are rare.

But in 2002, a European Commission investigation found “serious and systematic” irregularities in Dutch job-creation projects paid for from the European Social Fund and ordered the country to repay €157m (£137m) it received.

Although there were no accusations of fraud, the former Dutch public employment service was found guilty of numerous irregularities between 1994-96 when it managed financial aid from the fund.

The investigation revealed that expenditure and training hours declared had been “substantially” increased compared to spending and hours actually incurred.

The government agency also failed to keep the proper paperwork and that 45 job-creation projects paid for from the fund in the mid-1990s were executed carelessly.

At that point irregularities of that scale had not been found in the audits of structural funds in other EU countries and the request for more than 150m euro to be repaid was one of the largest in the history of the social fund.

The irregularities occurred during a period of low unemployment in the Netherlands.

The investigation was triggered in April 1999 when a visit from Commission officials in the Netherlands found that seven out of eight projects had clear errors.

The Scottish Government has accepted that the loss of the Euro funding following the UK’s withdrawal from the European Union will have a "significant impact" on the ability of local authorities, community groups, funding bodies and enterprise and skills agencies.

In November, ministers said they are still awaiting clarification on how a proposed replacement for European Structural Funds will work – two years after it was proposed.

A new Scottish Shared Prosperity Fund (SSPF) is due to be established as part of a UK-wide replacement.

Trade Minister Ivan McKee has said he expects the UK Government to transfer full control over replacement funding to the Scottish Government as the EU transition period ends.

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Highland Council is among the local authorities who have been anxious to have the Euro funding replaced and has told ministers that over three decades EU funds had "helped transform" the economic and social wellbeing the wider Highlands and Islands region, which has been one of the top three per capita UK beneficiaries of the latest seven year-round of structural funding.

"There are many demands on the public purse, but experience with previous/current EU structural funds and the direct and indirect benefits achieved, demonstrates the merits of having a dedicated and long-term (7 years) investment programme driving forward the growth of the regional economy," it said.