War for talent leads to creative tax avoidance

Nowadays they seem to be vying with each other to get rid of employees, rather than hire them.

But in reality the war for talent is being fought as aggressively as ever; there has not even been a ceasefire. Changing circumstances have produced a shift in the battle lines, however.

The banks have realised that attracting and retaining the best staff is just as important in a downturn as in a boom. But a big difference between now and two years ago is that they have far less money with which to do it.

This had led to a renewed search in the UK for schemes that minimise tax and National Insurance payments on bonuses, to allow staff to retain more of their dwindling remuneration.

A remuneration consultant who advises City of London employers, says: "The banks are more interested than ever in these schemes. They like to describe them as 'tax mitigation', but it's straightforward tax avoidance." He adds that banks dislike talking about them because they are worried about their image with the public. They also fear the UK Inland Revenue will spot what they are up to and close loopholes.

Tax experts say one scheme that has become popular in the past two years is for banks to use an offshore company that awards preference shares to London-based employees through a trust. Dividends are then paid and can attract tax at 25%, as opposed to the 40% income tax rate that might otherwise be payable.

The dividends can also escape National Insurance, which was raised by one percentage point by the government's budget three months ago - to 11% for employees and 12.8% for employers.

The tax consultant says: "Investment banks are the biggest market for so-called mitigation of tax and social security payments. This particular one hasn't been tested in the courts yet by the Inland Revenue. But the banks are frightened that it will be."

Banks used to pay some staff partly in gold and works of art. But the Inland Revenue put an end to such avoidance schemes in the mid-1990s and the banks have had to work harder since to find new ones.

Share options are another means of paying staff that have become more popular with banks, as a means of retaining staff rather than for tax avoidance. Banks have extended their use in recent years to greater numbers of employees, but there has been speculation that they may be used more sparingly in the future. Worries that options dilute the value of existing shares, together with the debacle at Enron, where many staff were left with options that were valueless, have begun to make them look unfashionable.

Damian Carnell, a compensation specialist at the consultancy Towers Perrin, says it is likely that all share options granted in the European Union will have to be shown on a firm's profit and loss account (P&L) by the end of 2005. At the moment they tend not to show up there and their absence flatters a firm's accounts.

Carnell says the change is on the way because the EU plans to adopt the standards of the International Accounting Standards Board, which itself is expected to change its rules soon so that options are recorded in the P&L.

But he adds this should make little difference to the popularity of options among employers. He says: "The changes will simply be discounted in the way options are handled. They will probably remain an important retention tool. And banks are hardly going to say that the only reason they have ever given share options is that they didn't show up in the P&L."

Falling share prices, however, have left share options deeply unpopular with many employees. One corporate financier at a US house says: "I have plenty of share options, but they're several fathoms under water and I couldn't care less about them."

But Peter Christie, a remuneration expert at the consultancy Watson Wyatt, says most staff have no need to worry. Christie says: "A variation of Black-Scholes methodology [which was designed for traded options] shows there's still plenty of value in share options.

"I wouldn't expect an executive of, say, a shoe manufacturer in Nottingham to be impressed by that argument, but people in the City of London understand."

The simplest way for banks to save money on staff is to pay tiny bonuses, or no bonuses at all, to people they would like to push out. The head of HR at one bank says: "That will happen a lot more in the next round of bonuses. Money is gravitating as never before to the few people at the top who banks really want to keep." These are the ones likely to benefit most from tax avoidance schemes.

Banks are also likely to save money by deferring increasing proportions of bonuses, and for longer periods - but will be constrained by the unpopularity of this with staff.

The size of bonuses paid this year varied enormously amid the economic uncertainty, making patterns hard to discern.

A survey by Monks, the pay consultancy, suggests some corporate finance staff in small houses even managed to secure bonus increases.

But with bonuses for most people sharply down, some staff are focusing on other aspects of remuneration. Matthew Webb, a human resources executive at UBS Warburg, says many employees there are showing increased interest in benefits provided through the firm such as medical care and long-term disability allowance. The firm has also increased minimum pension contributions by employees.

These are hardly the glamour weapons of choice in a recruiter's armoury - but in these lean times, every little helps.