Wednesday, 29 February 2012

TaxCast on Bankers' Bonuses

The Tax Justice Network is publishing monthly 'podcasts' suggesting improvements to the UK's tax system.  I've listened to this month's edition: most of it consists of monologues by Richard Murphy.

One of the subjects Murphy discusses is the taxation of bankers bonuses: is the whole bonus environment properly taxed at this time?  And my answer to that is no, the tax system is far too generous with regard to bonuses at present. Quite a number of these bonuses are now paid in shares.  That also means that quite possibly part of the bonus will now be recognized as capital gains rather than income, and as a consequence it might be taxed at a lower rate...
Yes, a substantial proportion of the larger bonuses is typically paid in deferred shares: a typical structure being that about half the bonus is in shares, and those shares vest in thirds one, two, and three years after being awarded.  The holder is not able to sell the shares until they have vested, and may forfeit them, particularly if he voluntarily leaves his job.  There are various government schemes to encourage share awards, but they do not cover the sort of large awards Murphy is concerned about.  So the tax treatment is simple: the shares are subject to both income tax and national insurance contributions, as described here.  Usually the awarding company meets these obligations by selling the appropriate proportion of the share award on its vesting date.  (The employee has the option to pay at the time of the award: some bankers will have done this two years ago in anticipation of the introduction of the 50% tax rate in April 2010.)  Contrary to what Murphy, a self-proclaimed tax expert claims, none of the bonus is recognized as capital gains.  Capital gains tax applies only to changes in the value of the shares after the time when income tax has been paid, just as it applies to any investment in shares.

Murphy continues:
The second issue is that actually we give an enormous subsidy to pay these bonuses.  When a bank declares that it's going to pay somebody a bonus of, let's call it a million pounds, in the UK they get tax relief on that payment.  This year they'll be getting tax relief of around 26% of that sum, so two hundred and sixty thousand pounds of that bonus of a million is effectively paid by reducing the bank's corporation tax bill.  Well if that's the case then we should be using the tax system to reprice bankers' bonuses and that can be done by simply removing the tax relief on the part of the bonus that we consider excessive.  Now this is a completely valid use of the tax system to deliver a social purpose, to raise money, and to save something which is causing harm to the market - and that's what these bonuses generally are perceived to do - should be priced by the tax system to discourage them.
Here he is quite right about the operation of the tax system.  Staffing costs, whether salaries, benefits, or bonuses, are considered to be operating expenses.  Corporation tax is levied at 26% on profits, which naturally are calculated net of operating costs.  He's also right that we could, if we wished, change the tax system to make large bonuses more expensive to pay, though I suspect the tax would be more effective if implemented as a payroll tax, following Alistair Darling's example two years ago, rather than by means of corporation tax.

But there are two problems with this.  First, if you make it harder for banks to pay bonuses, they will compete for staff by paying higher salaries instead - this happened in 2009.  And bonuses are preferable to salaries in that they give banks control of their staffing costs: they can and do pay less when they make losses or insufficient profits.  Second, the City of London is hugely profitable for the UK - PwC estimates the total tax contribution of the financial sector in 2010 as £53.4bn.  There are good reasons for banks to operate in London, but they're not so overwhelming that there's no level of taxation at which business will tend to shift overseas.  Darling judged correctly that his payroll tax would not do that, but he was careful to say that it would be for one year only (a year later Ed Miliband had forgotten that).  Murphy perceives banking as an evil that should be discouraged by taxation, but alas it is not within the UK government's powers to end the international banking system.  Is Murphy willing to forego many billions of pounds a year in tax revenues simply in order to express his distaste?

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