News that profit-related pay may be introduced in universities caused consternation among unions and triggered denials from university authorities this week. Alison Utley explains how such schemes work

Profit-related pay, already widely established in the private sector, is set to become increasingly popular in higher education if accountants are to be believed.

Of course they have a vested interest, but judging by the interest shown by universities in two seminars run by accountants Price Waterhouse last week their forecast may not be so far fetched. Trade unions, on the other hand, are deeply sceptical and the Association of University Teachers said it doubted whether PRP would ever get off the ground.

The timing of the accountants, however, could not be better. With universities' budgets stretched and payroll costs almost literally breaking the bank in many cases, schemes which promise savings while providing employees with healthy pay rises must be taken seriously.

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Profit-related pay is a government initiative to link payroll costs to profits. Flexible pay is the aim and generous tax relief is the incentive. Under registered schemes pay is exempt from income tax up to a maximum of 20 per cent of annual pay or Pounds 4,000, whichever is less. The schemes, which now cover 2.5 million employees nationwide, have improved since their introduction in 1986 and are estimated to have cost the Inland Revenue Pounds 1 billion in the current year. So why is the Government prepared to spend so much on PRP? The answer depends on who you talk to.

According to the 1996 green budget produced by the Institute of Fiscal Studies, "Firms can use these schemes to give pay rises at little additional cost to themselves but it is not at all clear why the Government should subsidise this. The initial intention, that the tax relief should be reversed after a period of years, seems appropriate."

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Lecturers' union Natfhe, which is preparing a document warning of the pitfalls of profit-related pay, says the future for tax relief on such schemes is "bleak". "It is unlikely that a government of whatever party will be able to sustain such a draw on the Treasury's resources."

The Government's consultative document, issued in 1986, identified two principal benefits of profit-related pay. The document said the schemes would lead to a closer identification of employees with the organisations in which they work. Second, and perhaps more importantly, if pay levels respond more rapidly to changing market conditions, output and employment should become less variable.

According to Price Waterhouse, PRP was introduced to induce companies not to reduce employee numbers if profits fell and to prevent them from making pay awards which they could not afford. PW points out that from the Government's perspective the annual cost of PRP is one fifth of the annual cost of someone who is unemployed.

Various schemes are on offer, some sharing the tax savings between employer and employee, while others give all of the tax savings to employees. The idea is that the PRP scheme reduces the pressure for wage increases, something universities would undoubtedly welcome, and could replace annual pay increases.

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Accountants play down the risk of losing pay rises or even having take home pay fall when there are no profits. Most schemes only link a percentage of any pay rise to profits, which to some extent cushions individuals against failures to meet profit targets. According to Price Waterhouse the generous level of tax relief means that if profits fall short there may be no reduction in take home pay. The university would need to nominate a PRP "pool" likely to be a fixed percentage of profits that must be paid to employees.

PRP can be introduced either as a bonus scheme, in lieu of a pay increase, or as a salary substitution scheme. For salary substitution schemes at least 80 per cent of employees must consent to a reduction in their existing salaries.

All schemes are governed by strict rules and must be registered with the Inland Revenue. The employer must show a profit figure that complies with the Companies Act. So universities would have to set up profit and loss accounts, probably for the first time. And it is this notion of profit which is making critics of PRP nervous.

The Association of University Teachers said it was uncomfortable with the idea as it was entirely inappropriate for universities to be talking about profit-related pay when profits were not on the agenda.

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A spokeswoman said institutions were hardly able to make ends meet: "There is something bizarre and unwholesome that the only way academic staff can improve their lot is by using tax manoeuvres that will ultimately lower the resources of government to pay for universities and other public services."

Natfhe agreed. The very act of using tax relief for increased income reduced the pressure for proper, secure annual pay awards and undermined national collective bargaining. "Our best advice would be to oppose the establishment of PRP."

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