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Law firms will have to give 9 per cent rises to their salaried staff merely to keep them on the same wage when tax relief on profit-related pay is phased out in two years' time.
Many City law firms have been running profit-related pay schemes as a tax break for their staff, rather than as a true bonus scheme. In a move which was widely predicted, Chancellor Kenneth Clarke's Budget announced the phasing out of tax relief applicable under the scheme over a period of two years, starting from April 1998.
Currently, staff agree to sacrifice up to £4,000 of their salary under profit-related pay schemes at the beginning of each year. Provided the firm makes a profit at the end of the year, the employees get the money back without paying tax.
Nigel Davey, head of legal audit at Deloitte & Touche, said: "It means that employees get £1,600 more than they would have done if that £4,000 had been taxed."
"Law firms are facing a personnel problem," he added. "Are they going to make good their staff's pay once tax relief is phased out? If they do, it's going to cost them quite a lot of money."
Davey said the phasing out of profit-related pay would only exacerbate the current wages spiral among City firms seeking corporate lawyers at assistant level.
Ian Dinwiddie, financial director of Allen & Overy, said: "This is irritating but I'm not unduly worried about it. It was widely predicted, so we had some time to prepare. And at least we have two years' grace and then it is being phased out gradually."
The amount employees can "sacrifice" will halve to £2,000 from April 1998 and halve again to £1,000 from April 1999.