Crackdown on schemes to avoid bonus tax

City advisers are braced for a crackdown on schemes designed to reduce the tax paid on bonuses to bankers and other professionals, who are enjoying their highest earnings since the late 1980s.

The authorities are already understood to be challenging one popular technique used by investment banks to avoid National Insurance contributions, by paying bonuses in the form of life policies that are subsequently cashed in. Tax specialists at leading accountancy firms believe that the Department of Social Security, which is responsible for NI contributions, is collecting material to mount a court action against other tax reduction plans.

Sandy Pepper, partner with Coopers & Lybrand, said: "It's fair to say that the DSS does not like these arrangements at all. And the Chancellor is on record as saying he doesn't like them."

Since the late 1980s, when the cap on NI contributions was lifted, employers have sought to avoid liability to a tax that amounts to a tenth of payroll costs by paying staff in such "currencies" as unit trusts, gold, diamonds, platinum sponge and fine wines.

Instead of introducing a general anti-avoidance provision, with exceptions where appropriate, the Government has merely blocked each loophole as it arises. Recently, employers and their advisers have sought more obscure methods in the effort to keep one step ahead of the authorities.

Though it would be relatively easy to do, there has been little effort so far to produce legislation cracking down on the NI avoidance schemes.

If the Government did decide to act it would be another blow to City institutions following the Chancellor's decision last week to close a loophole that gave significant tax advantages when companies carried out share buybacks and special dividends.

The belief there is widespread abuse of the system in the City has been fuelled by the discovery that Peter Young, the disgraced Morgan Grenfell Asset Management fund manager, had his bonus paid into a custodial account in Jersey,

Opinion in the financial services community is divided over the extent to which other organisations follow this practice, especially since having money paid into an offshore account carries no immediate tax advantages, on the grounds that it is where the recipient was based when earning it rather than where the money is paid that interests the Revenue.

Specialists stressed there were a lot of myths about Jersey and other offshore centres and claimed that much of the talk was hype aimed at drumming up business.

John Whiting, tax partner with Price Waterhouse, said: "Nowadays, it is more and more difficult to find a loophole and whenever they are found they get talked about on the conference circuit."

Just as the Revenue is zealous about collecting newspaper cuttings about City bonuses, it also sends officials to seminars devoted to saving tax.

David Williams, tax partner with Smith & Williamson, said: "There are some fairly sharp and aggressive tax inspectors who look after the affairs of people in the City and they don't accept any old nonsense."

Mr Pepper suggested much of the work done by him and his counterparts was connected with ever more sophisticated remuneration arrangements.

For example, if employers are seeking to build in an element of deferred pay to act as a handcuff, much effort goes into ensuring that the employee does not pay tax before he or she receives the money.

A DSS spokesman said the department kept the situation under review and acted against particular schemes when it felt it was appropriate.