An east London homeless charity has warned hundreds of its vulnerable service users they could be put at risk after it was presented with a £1million VAT bill.

Caritas Anchor House has been told by HM Revenue and Customs that it faces the bill for the development of “move on” flats to support homeless people.

The charity, based in Newham, provides accommodation for more than 230 homeless people a year. It also works with vulnerable groups, including those experiencing substance misuse, domestic abuse, mental health problems and offenders.

Caritas Anchor House has warned the unexpected cost will force it to mothball the development project, will place substantial pressure on its services and funds and will increase demand on local authority services.

The VAT was incurred after HMRC reviewed Caritas Anchor House’s description of services, determining its definition as a “residential and life skills centre” rather than a “homeless hostel” left it subject to VAT despite no change in the organisation’s services.

The charity has claimed that it is being penalised for positively and accurately describing its work, having previously been given advice that its VAT liability for the development would be £250,000.

It said the full cost of HMRC’s action could rise to £1.5million once costs to halt development and challenge the decision are included.

The charity was a finalist for the Third Sector Excellence Awards for Financial Management in 2009. Caritas Anchor House has appealed to the Government to reverse the decision.

The charity’s CEO House Keith Fernett said: “HMRC’s application of VAT in this case is devastating to our work and to the vulnerable people we support.

“We believe we’re being unreasonably penalised for accurately describing our operations despite not changing what we do.

“What makes this situation even worse is that we have worked incredibly hard to deliver a level of service with a reliance on donations and relatively little government funding.

“We hope HMRC will reverse its decision, and allow us to continue making a huge difference to people’s lives. Otherwise our work is at risk, and local authority services will be put under greater pressure.”

A spokeswoman for HMRC said it could not comment in individual tax claims, due to confidentiality laws, but urged the charity to ask for help.

She said: “VAT status is a matter of law, determined by the nature and activities of the individual organisation.

“Although the tax payable in law has to be paid, we will always provide practical support and advice when approached.

“Time to pay arrangements are available for those with payment problems and anyone in this position should talk to us as soon as they can so we can do everything possible to help.”