Ed Lester's pay structure, said to save him tens of thousands a year, leads to review of tax affairs of top civil servants
The chief secretary to the Treasury, Danny Alexander, is to be questioned by MPs on why the head of the Student Loans Company is being paid via a firm without tax being deducted.
An urgent question tabled by Labour backbencher Nick Brown in the Commons demands "a statement on the government's policy on use of tax avoidance devices by government departments and public servants".
SLC chief executive, Ed Lester, is said to save tens of thousands of pounds in tax by having his £182,000 salary paid gross to his private service company.
The Treasury has asked Whitehall to review all the tax affairs of top civil servants after it arrangement emerged.
The arrangement, entered into in 2010, was disclosed in a HM Revenue and Customs letter obtained under the Freedom of Information Act by Exaro News and BBC's Newsnight programme. It may cause dismayed among minister if it is seen that they have presided over a system in which senior civil servants have been able to minimise tax payments.
It is embarrassing specifically for the Treasury, which is committed to tackling tax avoidance and is planning to bring in a general tax avoidance rule in the budget.
The arrangement is also likely to be examined by the Commons public accounts committee, its chair, Margaret Hodge, said. She has the support of senior Tory on the committee, Richard Bacon.
Newsnight alleged that the arrangement was known to the higher education minister, David Willetts, but the department had been desperate to hire someone capable of sorting out the SLC after years of inefficiency. Alexander was said to be unaware of the arrangement although he was required to sign off Lester's pay deal in common with all public sector salaries of more than £142,500.
Alexander said: "I have asked Treasury officials to urgently review the appropriateness of allowing public sector appointees to be paid through an agency by a personal service company.
"I have also written to my cabinet colleagues asking them to carry out an urgent internal audit to ensure that all senior consultancy appointments provide value for money.
"As I have said before, I believe everybody should pay the right tax at the right time … that is why I've taken this action."
His aides believe this kind of arrangement was not appropriate in the public sector and that tax avoidance was "wrong".
Bacon said he was concerned that the HMRC had approved the arrangement. "It is simply inappropriate for a full time civil servant and accounting officer for the Student Loans Company to be paid gross of tax through a personal services contract," the MP said.
"My understanding is that this arrangement saver Lester tens of thousands of pounds each year, some of which would otherwise be paid in income tax."
The payment method allows Lester to pay corporation tax of 21%, rather than up to 50% income tax on his earnings.
Accountants estimated that the overall pay arrangements, known to have occurred with some BBC executives, may have saved Lester £40,000 a year, according to Newsnight.
Lester, who lives in Buckinghamshire, also receives £550 a week to pay for his travel and living expenses and cover his costs of getting to the company's offices in Glasgow.
In emails, a letter and memos, one civil servant at the Department for Business, Innovation and Skills described the arrangement as "tax efficient" for Lester.
A Treasury spokesman said Alexander had approved Lester's pay, though reduced by about £13,000, in continuation of terms agreed on a previously interim basis.
"The chief secretary to the Treasury is required to approve senior civil service appointments where the salary exceeds £142,500," he said. "Terms and conditions are negotiated by the appointing department, and presented to the chief secretary for approval of the salary level.
"In the case of the chief executive of the Student Loans Company, the chief secretary approved the overall pay, at a reduced rate and in a continuation of the interim arrangements previously agreed.
"The chief secretary was not made aware of any potential tax benefit to an individual."
Departments have been told that any appointments which do not provide value for money should be unwound as quickly as possible, the spokesman added.