It was revealed on BBC Newsnight last night that Ed Lester chief executive of the Student Loans Company has been receiving his civil service salary via a service company in order to avoid PAYE. He is not the only one...

At a glance

  • Full time civil service employee paid via service company
  • HMRC agreed no PAYE to be deducted
  • Use of ESC A37 - but twice
  • Treasury agreed but unaware of tax deal
  • HMRC made similar agreement with its IT officer
  • Both cases apparent exemption from IR35


The discovery of the details of Mr Lester’s pay deal was made following a freedom of information request by Exaro News and Newsnight.

The payment arrangement for his £182,000 civil service salary to be paid to a third party intermediary (his personal service company) had also been approved by HMRC - twice. HMRC appears to have agreed this when he was engaged on a temporary contract, and then again when he was taken on full-time. He also receives £550 per week in travel expenses for his commute to work, also apparently tax-free.

Danny Alexander, the chief secretary to the Treasury signed off the pay deal, but seems unaware of what he agreed. He told Newsnight he is now investigating further.

As all tax advisers will appreciate, payment of salary via a service company will save both tax and NICs. Mr Lester may well also be able to split his employment income with any fellow shareholders and so may be able to also avoid higher rate tax.

The news possibly comes as little surprise to some Members of the House of Commons Public Accounts Committee who following investigations into HMRC’s dealings with large business seem exasperated by some of Whitehall's practices. Margaret Hodge Chairman of the PAC has now said that they will investigate the matter. Fellow PAC member Richard Bacon said that it is “inappropriate for a full time civil servant to be paid gross of tax through a personal services contract”.

Keen readers of HMRC’s annual accounts will note that Mr Lester is not the only civil servant to have received such favourable treatment. In fact, HMRC is not adverse to agreeing favourable tax deals with its own staff. According to its 2009-10 accounts, HMRC has made similar agreements with its own officers.

Deepak Singh, was an IT officer with HMRC who did not make the cut following the protracted problems with HMRC’s PAYE computer systems: he was turned down for promotion. Following his resignation, he was then re-employed by HMRC, to do the same job at a rate equivalent to £600,000 p.a. In an added twist HMRC gave him a (presumably) tax-free lump sum of £19,200 to help him find a new job when his temp role finished.

Richard Bacon was also a member of the PAC in 2010, and was aware of Singh’s contract, however, looking at the PAC minutes of the time it seems that members were concentrating on his huge pay award and so were not made fully aware of the favourable tax treatment also afforded by HMRC. In the real world HMRC would expect an employer who pays an ex-employee do the same job to deduct PAYE. Failing that, such a situation would surely fall foul of the intermediaries legislation - IR35.  In that case income paid into the personal service company would be subject to PAYE as “deemed employment income”, removing the tax advantage.

One can only speculate as to whether Mr Lester and Mr Singh are enjoying income shifting or just rolling up profits in their personal service companies with the idea of extracting profits via liquidation (given the forthcoming changes to ESC C16).

How is this all done?

HMRC appear to have given Mr Lester the benefit of Extra Statutory Concession A37 but twice. It says:

“..It is also the practice of HMRC that where a company has the right to appoint a director to the board of another company, by virtue of its shareholdings in, or a formal agreement with, the second company then, provided the director is required to hand over to the first company any fees or other earnings received in respect of his directorship with the second company and does so, and the first company is chargeable to corporation tax and agrees to accept liability on the fees, those fees are treated as income of the company and not of the director, and tax is not deducted from the fees under PAYE. Where the first company is chargeable not to corporation tax but to income tax (for example, if it is a non-resident company not trading through a branch or agency in the United Kingdom) and agrees to accept liability, tax is deducted at the basic rate of income tax from the fees…”

It follows that if HMRC gave everyone the benefit of ESC A37, most employees would be paid via personal service companies!

As to Mr Singh’s favourable tax treatment – perhaps the PAC will now re-visit that.

Tax advisers may be speculating why Mr Lester and Mr Singh are also apparently exempt from IR35.

Health warning!

Do not try the above mentioned practices without obtaining professional advice:

  • Employers you may* have to account for PAYE and NICs if you start paying employees via service companies.
  • Service companies: IR35 may apply to your "deemed employment income".

* Some questions have been raised on this comment: we suggest that if you devise a scheme to rid yourself of employees by setting them all as "self-employed" via their own companies, so that they remain doing the same jobs as before, HMRC will probably shout "sham!" and the courts may agree. Besides which, in terms of employment law, this would be extremely difficult to stage manage without genuine redundancies.

Small print and links

EIM02500 - Employment income: directors' fees received by partnerships and companies: text of Extra-Statutory Concession A37

Public Accounts Committee HMRC 2009-10 accounts