UK disclosure laws become taxing issue

The disclosure requirements of the March 2004 Budget specify that any scheme devised to avoid tax is logged with the Inland Revenue for scrutiny. Since March about 100 have been registered but, according to tax accountants, few have anything to do with investment banks.

Jon Terry, head of the employee benefits practice at PricewaterhouseCoopers, said banks' use of arrangements to deliver compensation tax efficiently has fallen significantly in the past two years. "Changes to tax legislation and the Revenue's increased scrutinisation have been factors in some banks deciding not to implement such arrangements."

A partner in the employment tax business of one of the other big four accounting firms said half his tax avoidance clients used to be banks but the number is falling.

The effect on bonuses could be considerable. He said: "It is absolutely certain that some bankers will receive lower net bonuses this year now these schemes are not running."

Schemes typically work by shifting money from a form where it is taxable as income into one where it is taxable as capital gains. Given that the top rate of income tax is 40% and that capital gains tax can be as low as 10%, net bonuses could be lower by as much as a third as a result.

The disclosure requirements are the latest piece of legislation designed to reduce tax avoidance.

Euphemistically known as tax mitigation or tax planning, avoidance is legitimate and distinguished from tax evasion, its illegal cousin. But the tax authorities dislike avoidance and try to close loopholes they find.

Damien Carnell, a compensation specialist at consultancy Towers Perrin, said banks have been playing a game of cat and mouse with the Inland Revenue. "Banks have been prepared to pay for complex schemes, which only last a year or two before being banned."

Arranging avoidance schemes costs banks between 100,000 (€142,000) and 250,000 but savings can be huge: as well as improving net bonuses for employees, banks use them to avoid paying national insurance on bonuses, charged at 12%.

The City of London's interest in tax avoidance goes back decades. In the late 1980s and early 1990s bonuses were paid in gold bullion, wine and fine art to avoid national insurance. When that loophole closed, some employers switched to paying top performers tax-free loans of Turkish lira in the expectation that employees would immediately change it into sterling and pay the loan back after the lira plummeted, pocketing the difference. That, too, was banned.

Last year the British government went a step further and tried to stamp out employee benefit trusts by making money paid into them non-tax deductible for employers until employees had paid their dues.

This year the government raised its game. By demanding that all avoidance schemes are registered, it is tackling the spirit of avoidance instead of the intricacies of particular schemes.

The gains from the financial services industry could be considerable: in 2001 authors Richard Roberts and David Kynaston calculated that the City of London contributed 8.6bn in taxes, 7.5% of the UK total.

Avoidance has not been stamped out completely. Carnell said a few banks continue to operate employee benefit trusts. Even when trusts are non-tax deductible and employers are charged 30% corporation tax on money paid into them, there is a 23% saving compared with the 40% income tax and 13% national insurance contributions levied on income; the difference is split between bank and banker.

However, Terry said this year's avoidance schemes are more frequently based on complex stock payment programmes: employees are paid in the stock of a third company, often specially created for the purpose, the value of which is likely to rise in future.

A straw poll of four City of London human resources executives, all of whom declined to be named, revealed that none was operating tax planning schemes.

As well as the new legislation, most feared adverse publicity. One said: "There is tax avoidance and there is tax evasion and there is a space in between. We, as a firm, don't feel comfortable from a moral or reputational point of view with schemes set up by clever tax lawyers to help avoid tax and social security, even if they are legal."

So just who is behind the 100 or so avoidance schemes registered this year at the Inland Revenue? Footballers and pharmaceutical companies plus secretive financial services operations, say accountants. "Tax avoidance schemes are alive and kicking in owner-managed financial firms with a low profile," said a tax lawyer.

It does not take much to read between the lines: bankers may be paying tax on their bonuses this year; hedge fund managers probably will not be.