Not many people feel sorry for City high-fliers earning six-figure salaries and often even bigger bonuses. But one place where this small but high-profile group is particularly unlikely to get much sympathy is HM Revenue and Customs.
Over the past few years the Revenue has increased its efforts to crack down on tax avoidance and highly-paid bankers and executives are a prime target.
One tax planning technique that has been subjected to particular scrutiny is the dual employment contract, a form of employment that enables foreigners working in the UK to pay less tax.
Leading accountants say the Revenue has succeeded in extracting more tax, but it may have come at a high price, because hedge funds – one of the prime candidates for dual employment contracts – are considering leaving London to relocate in countries outside the UK with more friendly tax regimes.
Although dual contracts are particularly popular in the City, they are used by a wide variety of employers, particularly multinational companies. To be eligible, you must be a citizen of another country who works partly in the UK and partly outside.
Your UK work is covered by one contract and is subject to the usual tax and national insurance obligations. But you have a separate contract for your work outside the UK, and the income you receive from this work is tax-free provided you do not bring it into the UK. This practice has succeeded in reducing some people’s income tax bills by 50 per cent – or even more in some cases.
However, in April 2005 the Revenue issued an interpretation of dual contracts in its Tax Bulletin that Philip Davis, a tax partner at Ernst & Young, describes as “the first shot in a war”.
Since then, accountancy firms such as Ernst & Young have noticed a drop-off in the number of dual-contract employees among their clients.
Not even the Revenue knows how many people are on dual contracts, but Davis estimates that the number has halved over the past two years.
Paul Knox, a director at JP Morgan Private Bank, has also noticed a growing reluctance to use dual contracts. He says this is part of a broader erosion of tax advantages for people living in the UK but not domiciled here.
“It may well be that the Revenue have taken the view that they can’t win the battle on bringing in fundamental reform of the way ‘non-doms’ are taxed, but by making piecemeal changes they can achieve the same thing,” he says.
Knox says that companies’ human resources departments “like to have a low-profile relationship with the Revenue”. He says this discourages them from arranging dual contracts, which may attract unwanted attention.
SJ Berwin, an international law firm, says it advises clients to think carefully before using a dual contract, which it reckons is “really saying to the Revenue, ‘come and investigate us’”.
Not only can the Revenue question a company’s use of dual contracts, it can also raise the issue with individuals when they file a tax return.
To qualify for the dual contract loophole, an individual must perform two genuinely different jobs. It is not enough to spend some time working abroad. The two contracts must be independent, so that if you lose your job under one contract you can still continue to work under the other one.
The Revenue has set up a taskforce with the specific aim of squeezing more tax out of these arrangements. Davis at Ernst & Young says that for many hedge funds, the dual contract crackdown could be the straw that breaks the camel’s back.
“The hedge fund industry is being driven out of the UK,” he says, predicting that in a few years’ time London could lose its place as the world’s second-biggest hedge fund centre after New York.
