The Impact of Code Section 409A on Global Compensation Plans

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1 The Impact of Code Section 409A on Global Compensation Plans April 27, :30 am 12:30 pm Fredric S. Singerman, David M. Weiner, Partners, Seyfarth Shaw LLP and William J. Dunn, PricewaterhouseCoopers

2 Background: Section 409A 2

3 BASICS America Jobs Creation Act of 2004 Deferred compensation that is noncompliant is immediately taxable 20% excise tax on service provider, plus interest at underpayment rates Compliant document required New guidance expected in later this year 3

4 What is Nonqualified Deferred Compensation? Any arrangement under which employee (or other service provider) has a legally binding right during a taxable year to compensation which has not been actually or constructively received but which will be payable to the service provider in a later tax year No legally binding right if compensation can be unilaterally reduced or eliminated by the employer after services performed 4

5 What Types of Arrangements are Deferred Compensation? SERPs (supplemental executive retirement plans) Excess plans (401(k) wraps or other supplements to qualified plans) Salary and/or Bonus deferrals Phantom stock or restricted stock units Discounted SARs (stock appreciation rights) Deferred compensation for outside directors, non-employees 5

6 What is NOT Deferred Compensation? Certain Equity-based Compensation Incentive stock options and non-discounted stock options and SARs 423 employee stock purchase plans Restricted Stock Awards Short-Term Deferrals Broad-based foreign retirement plans Qualified Retirement Plans 6

7 Short-Term Deferrals Not deferred if compensation is paid by the later of the date that is 2-1/2 months from the end of first tax year (either service provider or service recipient) in which amount is vested Vesting: subject to a substantial risk of forfeiture requires further service Some unforeseeable administrative delay is acceptable 7

8 What types of limits are imposed under Section 409A? Timing and form of deferral elections Timing and form of distributions Termination of employment, hardship, disability and change in control Specified events or specified date only Change in election requires 5 year delay No acceleration of time or schedule of payment 8

9 6-Month Delay for Key Employees of Public Companies Distributions tied to separation from service must be delayed at least 6 months beyond separation (but not later than death) for key employees of public companies (defined to include companies in controlled group with stock traded on any established securities market which includes foreign exchanges and any over-the-counter markets) 9

10 Six-Month Delay Key employee is top 50 compensated officers earning at least $140,000 (as indexed) plus certain shareholders Look at 12-month period ending on an identified date; if key employee on identified date then subject to 6-month delay for the 12-month period starting the 1 st day of the 4 th month after the identification date 10

11 Effective Date Effective 1/1/05 for deferrals earned or vested on or after 1/1/05 Grandfathered deferrals: plan in place before 10/3/04 no material modifications since 10/3/04 Transition Rules New elections by 12/31/06 Plan documentation by 12/31/06 11

12 Application to Parent Company Arrangements and Expatriate & Impatriate Employees 12

13 Excluded Foreign Deferred Compensation Arrangements Contributions excludable under bilateral income tax treaty Participation in a broad-based foreign plan of a non-us employer by a nonresident alien and certain resident aliens (other than green card holder) Participation in a broad-based foreign plan of a non-us employer, with respect to nonelective deferrals of foreign earned income up to Section 415 limits 13

14 Excluded Foreign Deferred Compensation Arrangements Any social security system of a foreign jurisdiction that is subject to a totalization agreement with the US Any government-mandated plan that is part of the foreign jurisdiction s social security system De minimis amounts ($10,000 or less) deferred by a non-us employer to a foreign plan based upon a nonresident alien s services performed in the United States 14

15 Parent Company Arrangements Extended to US Employees Section 409A will apply to deferred compensation otherwise taxable in the US Do home country incentive compensation arrangements that provide for the deferral of income comply with Section 409A? o Consider vesting requirements o Consider employer discretion over timing of payment Off-shore funding of arrangement 15

16 Impatriate and Expatriate Arrangements Continuing participation in foreign parent company plan previously earned and vested amounts paid in the US previously earned amounts that become vested based on US service amounts earned in the US (consider compliance issues above) 16

17 Impatriate and Expatriate Arrangements Severance Agreements Safe-harbor exception for severance upon involuntary termination limited to 2 x Section 401(a)(17) limit ($220,000), with payments ending by 2 nd year after year of termination 6 month delay requirement Certain reimbursements exempted if paid by end of second year One-off arrangements pose significant issues: Is compensation subject to a good reason provision deferred compensation? Gardening Leave may be termination of employment Acceleration of deferred compensation 17

18 Application to Global Equity Arrangements 18

19 Pitfalls: Equity Compensation Modifications, extensions or renewals may be deemed a new grant which could cause 409A treatment to apply Acceleration of vesting not a modification Reduction in exercise price deemed a new grant Extension of exercise period may be OK if not beyond 15 th day of 3 rd month after date award would have expired or, if later, end of calendar year in which award would otherwise expire 19

20 Problems with foreign equity plans Options granted below fair value Options over shares that do not qualify as service recipient stock Offshore trust funding Permitted distribution violations Broad use of RSU s which do not qualify for Section 83 (property) safe harbor 20

21 Fair value grants Options in certain countries are granted at some type of pre-grant average traded value (e.g., France) US expats may participate in these plans Proposed Regs provide that fair market value may be based upon a 30 day average selling price before or after the grant, if the option grant commitment is irrevocably made before the beginning of the specified period, and the valuation method is used consistently for grants of stock rights under the same and substantially similar programs. Discounted stock options and SAR s can be amended to provide a fixed distribution date through December 31,

22 Options over other classes of stock Under Section 409A Service Recipient Stock can only be common stock Must be the class of common stock that has the highest aggregate value of any class of common stock of the corporation, determined on the grant date Stock cannot have preference as to dividends or liquidation rights May include ADRs if the stock to which the ADRs relate would otherwise meet all other requirements Foreign equity plans (particularly in the UK) often grant options over special classes of stock These options will not qualify as service recipient stock and will not qualify for the option safe harbor 22

23 Offshore funding Limitations under corporate law on the use of Treasury stock in many foreign countries prompts companies to use offshore trusts as holding devices for equity compensation plans These offshore trusts will violate section 409A to the extent the employee has a vested right to payment of plan benefits Watch out for good leaver provisions Are options a problem if the underlying shares are held offshore? 23

24 Permitted distributions Foreign plans often provide for distribution arrangements that do not meet the permitted distribution rules, e.g, Employer discretion to accelerate payment Plans that allow payment upon separation from local service, but not from separation from corporate service Plans which call for change of control payments that do not meet qualified Section 409A change of control rules 24

25 Questions? Thank you for your participation 25