CUSTOMS investigators swooped on a major Lancashire County Council depot as part of a £60,000 contracts probe.
A worker at the Area East offices in Ridings Lane, Whalley, was arrested after the HM Revenues and Customs raid.
He has been suspended, county council bosses said.
Staff were initially left in the dark as officials seized documents and other evidence from the depot, which is the main highways and engineering base for East Lancashire and is responsible for road maintenance, gritting and bridge repairs in East Lancashire.
But tax bosses said the raid was part of an inquiry into VAT fraud involving building sub-contractors working for the authority.
It is understood two other men arrested as part of the probe are sub-contractors.
A HM Revenues and Custom spokesman said: “We made three arrests on Tuesday linked to a suspected VAT fraud in the building sub contractors’ trade.
“All the men, who are from the Blackburn area, have been bailed until March 2013.”
The men involved in the probe, who have not been named by HMRC, are aged 42, 43 and 72.
A Lancashire County Council spokesman said: “We can confirm a member of staff has been suspended and we are fully co-operating with an investigation led by HMRC.”
In a separate incident, also involving county council depots, an investigation has been launched over allegations that 19 workers were involved with the theft of scrap metal.
As reported in the Lancashire Telegraph, highways staff have been quizzed about how leftover items, such as iron grids and telegraph poles, are disposed of after jobs are completed.
No decision has yet been made on whether any of the staff will face disciplinary action or criminal charges.