The Inland Revenue is threatening to drag EDS through the courts unless compensation is agreed for overpayments that resulted from problems with the new tax credit IT system.
A software error on the EDS-designed tax credits IT system resulted in overpayments to 455,000 households in 2003 totalling almost £100m and the Inland Revenue has admitted it may be forced to write off more than £50m of that sum.
But talks over compensation have become deadlocked and, following an executive committee meeting of the HM Revenue and Customs department (HMRC), the Revenue has issued a statement warning it will sue EDS and air all the details of the tax credit problems in the High Court.
An HMRC statement said: "HMRC is clear that if it is not possible to reach an acceptable negotiated settlement, it will commence legal proceedings. Such proceedings will begin with the issue of HMRC's claim and detailed particulars of [the] claim which will be public documents in the Technology and Construction Court of the High Court."
John O'Brien, analyst at Ovum Holway, said in a research note that a court case could be extremely hazardous to EDS' already battered reputation in the public sector.
"Political pressure is bearing down and EDS will be keen to avoid this situation being dragged through the courts. However, the company will need to be careful how it plays the situation; as well as the potential millions, the company's reputation across the public sector is at stake should things get nasty," he said.
A spokesman for EDS said: "We continue to progress negotiations and hope they can bring about a settlement without litigation."