Taxman closes loophole on City bonuses

The Inland Revenue has closed two tax avoidance loopholes that City banks were using to boost bonuses for their star bankers and brokers.

Dawn Primarolo, the Paymaster General, has outlawed 'manufactured' payments and 'gilt strip' payments - although the move comes too late for this winter's bonus season and may already have cost the Exchequer tens of millions of pounds in lost tax.

'Schemes like this rob honest taxpayers and essential public services of revenue, and we are determined to take all appropriate action to counter them,' Primarolo said.

Manufactured payments usually occur in the City when a firm 'lends' securities to a star employee, who as the temporary 'owner' of the shares receives an interest or dividend payment.

The employee eventually has to return a sum equal to this payment to his employer, as well as ownership of the securities. But he can take advantage of the differing tax rates governing dividend payments and other forms of income in order to lessen his overall tax bill.

This 'artificial' arrangement is understood to have become increasingly attractive to those earning more than a million pounds a year, most of whom work in the financial services industry.

Firms have also been selling high-earning employees 'strips', securities that grant the right to receive the interest due on government bonds, and then repurchasing them in an equally complex scheme that also saves the employees millions in tax.

The Revenue's move to shut down these avoidance loopholes follows its abolition of the famous 'turkish lira' scam several years ago.

Under that scheme, top bankers were given 'loans' by their firms in a soft currency, such as the lira, which they immediately converted into sterling.

By the time the 'loan' needed to be repaid, the lira had lost much of its value and the banker needed to hand over only a small sterling sum to pay it back.