The Government today said it was ending a deal under which the head of the Student Loans Company has been paid via a company without tax being deducted.
The Treasury Chief Secretary Danny Alexander announced the move after criticism that it was allowing Ed Lester to save tens of thousands of pounds in tax.
He also pledged to "unwind" any similar arrangements across the rest of the public sector.
The arrangement with Mr Lester, entered into in 2010, was disclosed in an HM Revenue and Customs (HMRC) letter obtained under the Freedom of Information Act by Exaro News and BBC Newsnight.
The revelation is embarrassing for the coalition, which has been mounting a high-profile campaign against tax avoidance.
Responding to an urgent question from Labour in the Commons, Mr Alexander said the way in which Mr Lester received his £182,000 salary was now being changed.
"The Student Loans Company will, for the remainder of the contract in question, change the arrangements and deduct tax and National Insurance at source," the Liberal Democrat said.
"Across Government, if any appointments are found, whether agreed by this or the previous government, which do not provide value for money I would urge departments to seek to unwind them as quickly as possible and as quickly as is compatible with securing good value for public money.
"At a time when we all have to pull in the same direction to tackle the country's financial problems, it is essential that we all pay our full and fair share.
"That is why I have taken this action to make sure Government departments do not support tax avoidance schemes."
Mr Alexander signed off Mr Lester's pay deal in common with all public sector salaries of more than £142,500.
He apparently insisted the package was reduced by £13,000 when the interim appointment became permanent in January last year.
However, Mr Alexander told MPs: "I was not made aware of any tax benefit to any individual in this case."
The Student Loans Company insisted it had followed "all Government guidelines" over the chief executive's pay.
"Ed Lester accepted the position as permanent chief executive and accounting officer to the Student Loans Company on a two-year contract, which was formally announced in December 2010," a spokeswoman said.
"He was offered this post after a solid performance as interim CEO, where his leadership led to considerable improvement in the company's overall performance.
"SLC followed all Government guidelines on the appointment and remuneration of the CEO.
"Mr Lester's two-year contract with the SLC officially started on 1st February 2011 and will end on 31st January 2013."
Earlier, Business Secretary Vince Cable defended the SLC chief executive.
He described Mr Lester as "an exceptionally useful individual who has helped to turn round that organisation".
"The arrangements under which the negotiations took place involved substantial value for money for the taxpayer, a tax cut by the individual and we will pursue matters of public concern on the tax issues," Mr Cable said.
Labour higher education spokeswoman Shabana Mahmood wrote to universities minister David Willetts, demanding to know whether he or Mr Alexander signed off Mr Lester's employment arrangements.
Ms Mahmood asked to know when approval was given by the Business Department, the Treasury and HM Revenue and Customs, how much tax and national insurance was avoided and whether any other similar arrangements are in place.
"It is deeply concerning that David Willetts was happy for the chief executive of the Student Loans Company to be appointed in this manner," said Ms Mahmood. "That's why I have written to him to demand answers.
"It is clear that the Government still has questions to answer about this issue. We need to know which ministers signed off these arrangements, and who was aware of the tax and national insurance arrangements in the contract.
"We need to know why ministers thought this to be an acceptable arrangement - especially at a time when the economy is flatlining, people are being squeezed and David Willetts is tripling tuition fees.
"If ministers have sanctioned a pay deal for a senior official which appears to be designed to make it easy for him to avoid paying tax, it is clear that the Government are totally out of touch on this issue."