Severe progressive neurological paediatric disease mucopolysaccharidosis III type C is caused by mutations in the HGSNAT gene leading to deficiency of acetyl-CoA: α-glucosaminide N-acetyltransferase involved in the lysosomal catabolism of heparan sulphate. To understand the pathophysiology of the disease we generated a mouse model of mucopolysaccharidosis III type C by germline inactivation of the Hgsnat gene. At 6-8 months mice showed hyperactivity, and reduced anxiety. Cognitive memory decline was detected at 10 months and at 12-13 months mice showed signs of unbalanced hesitant walk and urinary retention. Lysosomal accumulation of heparan sulphate was observed in hepatocytes, splenic sinus endothelium, cerebral microglia, liver Kupffer cells, fibroblasts and pericytes. Starting from 5 months, brain neurons showed enlarged, structurally abnormal mitochondria, impaired mitochondrial energy metabolism, and storage of densely packed autofluorescent material, gangliosides, lysozyme, phosphorylated tau, and amyloid-β. Taken together, our data demonstrate for the first time that deficiency of acetyl-CoA: α-glucosaminide N-acetyltransferase causes lysosomal accumulation of heparan sulphate in microglial cells followed by their activation and cytokine release. They also show mitochondrial dysfunction in the neurons and neuronal loss explaining why mucopolysaccharidosis III type C manifests primarily as a neurodegenerative disease.