Deferred Compensation Outside of the United States Friday, 28 April 2006, 12:00-13:00

Transcription

1 Deferred Compensation Outside of the United States Friday, 28 April 2006, 12:00-13:00 Narendra Acharya Baker & McKenzie (Chicago) Agnes Charpenet Baker & McKenzie (Paris) Monika Dietrich Baker & McKenzie (Zurich) Luc Meeus Baker & McKenzie (Brussels)

2 Overview of Presentation Introduction to deferred compensation concept Background changing US rules Belgium/France/Switzerland Example to illustrate differences Other considerations Takeaways key implementation questions

3 What is Deferred Compensation? Case 1 No deferral Employee receives EUR 1000 on 1/08/06 and is subject to income tax and social insurance in Case 2 Deferral for 3 years Employee makes a timely election to receive EUR 1000 on 1/08/09 instead of 1/8/06 and is subject to income tax and social insurance in 2009 (rather than in 2006).

4 What is Deferred Compensation? Why? amounts grow at pre-tax yields, expect lower bracket at time of payout Base salary generally not deferred More typical examples include: Incentive bonus plans which permit participants to defer receipt (and taxation) of payout Restricted Stock Unit ( RSU ) plans which contain deferral election to receive shares at some later date (i.e., even after vesting) U.S.-centric models

5 Valid Deferrals/Timing of Elections At what point is it too late for participants to elect to defer payment? Other factors Invalid deferral leads to taxation of participant/employer withholding before cash received No longer an incentive

6 Substantial Changes to U.S. Rules Section 409A Guidance under Notice & Proposed Regs. Generally effective January 1, 2005 but transition rules Penalties include: (i) accelerated income inclusion, (ii) 20% excise tax, and (iii) interest and penalties.

7 International (Non-U.S.) Aspects of 409A US expatriates may participate in non-us retirement and other plans which do not comply with 409A. Non-US employees working in the US may continue to participate in their home country retirement and other plans which do not comply with 409A. Proposed Regulations provide exceptions for foreign broad-based plans in both cases. In many cases, funding of non-us trusts will trigger 409A income recognition where the trusts have US tax resident beneficiaries.

8 But Also Consider Non-US Rules How are deferred compensation plans treated outside of the United States? These rules would apply to individuals subject to income tax in the host jurisdiction Both local residents in the jurisdiction as well as expatriates on assignment in the jurisdiction.

9 Let s Look at Some Specific Jurisdictions Belgium, France and Switzerland (canton of Zurich) Is the issue specifically addressed under local tax laws or inferred by applying general principles under local law? Generally, an absence of specific guidance in most jurisdictions.

10 Belgium - General Domestic deferral programs are not common. US deferral programs are being imported increasingly. No specific domestic tax or social insurance rules available in Belgium. Analysis is thus based on general tax and social insurance rules and is very fact driven.

11 Belgium Income Qualification Tax Rates The deferred bonus or deferred award is taxed as professional income at the normal progressive income tax rates (between 25% and 50%, not including local taxes) (Article 31 ITC). Discretionary nature of the award does not change the aforementioned. Irrelevant that the grant is made by US parent company and not by the local employer (Com. IB 30/1).

12 Belgium Taxable Moment No specific rules regarding deferral of income. General rules: - Professional income is taxed when paid or attributed (Article 360 ITC Article 204, 3, b) RD/ITC). - Attribution : the date upon which the beneficiary can effectively dispose of the income or the date upon which it is available for payment.

13 Belgium Taxable Moment - If the income is not available for payment due to an election of the employee made after the income was paid or attributed, there will be no deferral of the taxable moment. - Tax authorities tend to have a strict view and tend to consider that compensation is taxable if it is credited for the benefit of the employee in the books of the company, whether or not it is actually paid, if the employee has an unconditional right to the compensation even though such compensation is not payable until some future time. Majority of the case law tends, however, to disagree with this strict view.

14 Belgium Deferral Programs Possible on the basis of the aforementioned rules. Should relate to discretionary grant and not to base salary provided for in an employment agreement (discussion on attributed ). Ideally performance based, but time based is not excluded.

15 Belgium Deferral Programs Moment to elect deferral: Before there is payment or attribution. Preferably before the performance / measurement period. To be phrased as a hypothetical question: if we were to grant you a discretionary bonus when certain conditions are met, would you like to receive the bonus in 2008 or in 2010?

16 Belgium Deferral Programs Election during the performance or measurement period should still be possible if done before the actual payment or attribution date - however less certain (unpublished private letter ruling: elect deferral before the employee is informed of the amount that is due to him). Strengthen the deferral by adding a contingency element (e.g., forfeiture if dismissed for cause), but should not be strictly necessary.

17 Belgium Deferral Programs Social insurance: generally follows the same analysis with respect to triggering event as for income tax purposes. Social insurance contributions (± 35% for the employer and 13,07% for the employee) are, however, only due if the remuneration is borne by the local employer (i.e., directly or indirectly charged back to local employer or granted upon the instruction /on behalf of the local employer).

18 Belgium Conclusion Deferral should be possible (recent informal ruling)- risk of requalification Moment of election is crucial Documents are crucial Avoid provision in the books Ideally provide contingency element Consider applying for a tax ruling

19 France - General Deferral plans are not common in France. No specific rules available in France. General principles apply for both personal income tax and social insurance purposes.

20 France Taxable Moment No specific rules regarding deferral of income. General rules: - Tax treatment: - Income tax applies at the time the participant has available income (Article 12 of FTC). - Available means: when income may be collected at the discretion of the individual and/or when income is credited to the individual s account. - Social insurance applies at the time the participant is credited and effectively paid the income.

21 France Deferral Programs Deferral may work under certain circumstances: - Mandatory deferral (no election by participant). - Only income subject to performance condition and not to base salary.

22 France Deferral Programs Moment to elect deferral: Election is made prior to the date the participant has available income and prior to the date the participant knows he is entitled to the payment (i.e., when satisfaction of performance condition is known or measured).

23 France - Conclusion Limit to the deferral program - Risks to substitute (a) amount fully taxable and fully subject to social insurance with (b) a favorable taxed award not subject to social insurance: disqualification of French qualified awards (options /RSUs). Unlikely to see legal or other changes on this topic.

24 Switzerland Federal vs. Canton rules Domestic deferral programs are not common but US deferral programs are being imported increasingly. No specific rules in Switzerland with respect to deferral therefore, general principles apply.

25 Switzerland Income Qualification The deferred bonus or deferred award is taxed as professional income at the normal progressive income tax rates (between approx %, depending on canton and municipality). Irrelevant that the grant is made by US parent company and not by the local employer.

26 Switzerland Taxable Moment No specific rules regarding deferral of income General rules: - Professional income is taxed when participant has irrevocable right. - Irrevocable right : the date upon which the participant can effectively dispose of the income.

27 Switzerland Taxable Moment - If the income is not available for payment due to an election of the employee made after the income was paid or attributed, there will be no deferral of the taxable moment. - Case by case discussion with the competent tax authorities is necessary.

28 Switzerland Deferral Programs Possible on the basis of the aforementioned rules. Should relate to discretionary grant and not to base salary. Again, discussion with tax authorities is highly recommended (on a case by case basis).

29 Switzerland Deferral Programs Moment to elect deferral: Before the participant knows whether or not he will receive a payment and before he becomes entitled to receive the payment amount. Must be before the end of the performance / measurement period. To be phrased as a hypothetical question: If we were to grant you a discretionary bonus when certain conditions are met, would you like to receive the bonus in 2008 or in 2010?

30 Switzerland Deferral Programs Strengthen the deferral by adding a contingency element (e.g., forfeiture if dismissed for cause), but should not be strictly necessary. Social insurance: generally follows the same analysis with respect to triggering event as for income tax purposes.

31 Switzerland Legal Changes Draft of new law with respect to taxation of employee benefits. However, the new law does not provide any specific rules with respect to deferral. As long as new law has not entered into force, advisable to seek ruling from the competent tax authorities.

32 Switzerland Conclusion Deferral should be possible Moment of election is crucial Documents are crucial Ideally provide contingency element Applying for a tax ruling highly recommended

33 Range of Timing Elections Choices include: Before the performance cycle begins At the beginning of the performance cycle Before the performance cycle ends Before the amount is measured Before the amount is known to the participant Before the participant is entitled to receive the amount Before the participant receives the amount

34 Example Multiple Year Incentive Plan Participant is eligible for a cash incentive payment based upon performance during a 3-year cycle (1/1/06 to 31/12/08). Incentive amount is calculated and then communicated to participants on 28/02/09. Payment is ordinarily made to participants on 15/03/09. Plan allows participants to make an election to defer payment from 15/03/09 and alternatively receive an RSU which will payout in shares on 15/03/12. The underlying number of shares that the RSU represents will be fixed by dividing the deferred payment by the FMV of the shares on 15/03/09.

35 Example Time Line Performance period Calculation Payment Deferral 1/01/06 31/12/08 28/02/09 15/03/09 15/03/12

36 Example Multiple Year Incentive Plan Belgium: election ideally before the performance cycle; to be phrased as a hypothetical question; ideally no provision in the books of the grantor. France: election at the beginning of the performance cycle (or even before the performance cycle begins) shall be acceptable since the participant does not know with certainty whether he will even be entitled to a cash payment (or the RSU grant). Unlikely for the RSU grant to meet the requirements of a French tax-qualified RSU.

37 Example Multiple Year Incentive Plan Switzerland: election needs to be made before participant knows whether or not he will receive a bonus payment and before he knows what the amount of the bonus payment will be. If election is made at the right time, the grant of RSU is not a taxable event but only the vesting of the RSU. Ruling advisable! Social insurance usually follows tax treatment

38 Some Other Jurisdictions Canada Salary Deferral Arrangement rules Impact on RSUs Brazil Many countries do not permit deferrals

39 Other Considerations Are the social insurance rules synchronized with income tax recognition rules? Employer reporting of valid deferrals? Employer withholding of valid deferrals. Expatriate and cross-border issues.

40 Takeaways! Rules are very specific to jurisdiction. Be wary of exporting US plans (even 409A compliant plans) to rest of the world. At the same time, local rules may be less strict than the new US requirements. Not like stock options (where generally viable in the majority of jurisdictions) Consider the following questions for the initial jurisdictional analysis:

41 Threshold Questions Does the jurisdiction have rules which address deferred compensation? Is it possible to make an effective tax deferral under local law? If possible, what are the timing requirements to make a deferral election? Are there specific issues that should be addressed in the (grant) documents? Is it problematic if the employer makes a provision in his books for the deferred compensation? Do the same requirements apply for social insurance purposes? What employer reporting/withholding requirements might apply?

42 Questions? Thank you for your participation