Loan boss's tax dodge received HMRC approval

The special tax deal he agreed with the Government will be rescinded immediately, it has been announced (PA)

Britain's most senior civil servant personally signed off on a deal that allowed the head of the Student Loans Company to avoid paying thousands of pounds in tax and national insurance.

Gus O'Donnell, then the Cabinet Secretary, agreed that Ed Lester could be paid through a complicated system of company accounts which allowed him to pay tax on his £182,000 earnings of just 21 per cent – rather than up to 50 per cent income tax. The decision was also approved by HMRC despite regulations, introduced in 2000, which should have prevented the tax dodge.

Amid deep government embarrassment over the deal, the chief secretary to the Treasury, Danny Alexander, was called to Parliament yesterday. He disowned it and said it would be immediately cancelled. He also pledged to "unwind" any similar arrangements in the public sector. Whitehall sources suggest some NHS and local authority managers may be paid in the same way.

The decision to approve Mr Lester's unusual tax arrangements was taken at the highest level. They were agreed by Mr Alexander, the Universities minister, David Willetts, Lord O'Donnell and officials at HMRC. Under the complicated deal, the Student Loans Company paid Mr Lester's gross salary to the executive recruitment company for whom he had been working previously, which in turn paid Mr Lester's own private company.

In getting approval for the deal, the Department of Business argued that it allowed the Government to save around £80,000 that it would have had to pay to the recruitment company as a "finder's fee" if it had taken on Mr Lester directly on to the payroll. But they appear not to have calculated the total loss to the taxpayer of lower rate of tax Mr Lester was paying.

It is unknown why HMRC also approved the arrangement – a spokesman said they could not comment on individuals' tax affairs.

The revelation is also embarrassing for the Coalition, with its high-profile campaign against tax avoidance.