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Until the pips squeak

14 April 2009 / Mike Truman
Issue: 4201 / Categories: Comment & Analysis , Admin , Companies
MIKE TRUMAN looks at how a retrospective tax on bonuses paid by failed banks could be structured


  • Various proposals have been made for taxing bankers’ bonuses.
  • Amendments could be limited to ITEPA 2003 for one year only.
  • Doubling amount charged imposes an effective 80% tax rate.
  • Pensions can be taxed by removing the benefit exemption.

Everyone else is at it, so why shouldn’t we? The US Congress has passed a law imposing a 90% tax on those earning over $250,000 employed by a financial institution that has received more than $5 billion in government help (although it has yet to be signed into law by President Obama).

TIME magazine has suggested that the charge should instead be 50% but on all bonuses paid for the past four years, on the grounds that those who left their jobs before the dam burst should not escape.

Here in the UK, Trevor Johnson in Taxes (30 March) proposed, slightly more tongue-in-cheek, that a 100% tax should be charged on pension income over £150,000 received by any ‘relevant person’; the definition of a relevant person being that they were, on or before 1 October 2008, a Scottish taxpayer (as defined in the Scotland Act 1998), a Knight Bachelor and had the initials FAG.

He even imposed the tax on the executors of the relevant person after his death, but thoughtfully provided an exemption if the death was ‘carried out for bona fide commercial purposes and not as part of a scheme or arrangement, the main purpose or one of the main purposes of which is the avoidance of tax’.’

Real drafting

Trevor’s idea is very appealing, but if we’re going to look at this, let’s see how it could be properly drafted. It is tempting to start by creating a new rate of tax as well as a new definition, thereby having to amend both ITEPA 2003 and ITA 2007, but this is probably unnecessary.

I would suggest instead just concentrating on ITEPA 2003, but artificially creating a new rate of tax by increasing the amount of income charged. All references below are to ITEPA 2003 unless otherwise noted.

The main charging section is s 9. This says, in the case of general and specific earnings separately, that the amount to be charged is the net taxable earnings or specific income from employment in the year.

Given that we are talking about cash bonuses, I think it will be enough to just amend this for general earnings:

‘9 (2) In the case of general earnings other than earnings from a failed bank, the amount charged is the net taxable earnings from an employment in the year.

'9(2A) In the case of general earnings from a failed bank the amount charged is:

'i) for the first £250,000 of net taxable earnings in the year, those earnings; and

'ii) for the excess over £250,000 of net taxable earnings in the year, twice those earnings.’

I’m proposing to impose this as a one-off liability for 2008-09, so the tax liability it creates is 80% on general earnings over £250,000.

Admittedly that does not take into account share incentives, but it is a rough and ready way of catching those who took significant incomes from failed banks during the tax year in which they would all patently have collapsed had they not been propped up by the Government.

But how do we define the failed banks? Fortunately there is a simple way to do this, arising from the creation by the Treasury of an arm’s length company, UK Financial Investments Ltd, to manage its holdings in the banks it has had to prop up.

It is still in the process of taking over the management of the investments, but the deadline for the 2008-09 tax return should allow some leeway here, with an addition to s 7:

‘7(7) ‘A failed bank’ means a financial institution or the subsidiary of a financial institution, any shares in which have been under the management of UK Financial Investments Ltd at any time prior to 31 January 2010.’

Pension excess

The assumption of my changes is that UKFI will use their vote to ensure that excessive bonuses are not paid in the future; that is why they are only going to be imposed for 2008-09.

But what about the issue that started this in the first place – the substantially increased pension due to Sir Fred Goodwin?

That can still be dealt with by reference to 2008-09 and by a change to a provision of ITEPA 2003.

Section 307(1) currently exempts employees from a liability to income tax on the payment of pension contributions by their employer. It already has exemptions, 1A and 1B, to do with insurance against the employer’s insolvency, so we can add a further one:

‘307 (1C) Subsection (1) does not apply to so much of a contribution made by a failed bank as exceeds £100,000.

'307(1D) In a defined benefits scheme, the amount of the contribution made by a failed bank for the purposes of 1C above shall be deemed to be the actuarial value of the changes made to the pension benefits of the employee during the tax year.’

This provision does not impose a higher tax on the pension itself as it is paid, but it does impose a liability on the benefit of the contribution.

Although the cost of Sir Fred Goodwin’s pension was widely reported as £16.9 million, it appears that this is an actuarial calculation based on the increase in his pension and the fact that he was given early retirement.

The tax system has a way of valuing this, in FA 2004, s 234, but it is fairly rough and ready.

Given the small number of people involved, a negotiated actuarial value is more appropriate.

Residual charge

Taking the amount out of charge means that the benefit falls into the residual charging section, s 201.T

his is in Chapter 10 of Part 3, meaning that it falls into the definition of general earnings by virtue of s 7(5)(b). Since it is general earnings from a failed bank, it would be caught by my new 9(2A) and charged at 80% if the total employment package was more than £250,000.

That would obviously be a penal amount to find in one lump sum when the pension is payable over many years, so the taxpayer has the option to waive the pension prior to 31 January 2010 and avoid the liability.

Finance Act 2009 could bring these new sections in for one, retrospective, year only.

Retrospection is not normally something to be supported in a taxing statute, but it has been used in cases where it was clearly necessary in the past, so arguably it should be here.

Those affected might want to complain that this is a breach of their human rights to quiet enjoyment of their property.

On the other hand, taxpayers might want to argue that, as it is our money that is going to pay them, allowing them to keep it is a breach of our human rights.

Issue: 4201 / Categories: Comment & Analysis , Admin , Companies
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