UK and European Employment and Benefits Law Update

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1 February 2008 UK and European Employment and Benefits Law Update By Anna Sanford and Chris Bracebridge AT A GLANCE This Stay Current summarises compensation, benefit and tax rate increases in the UK during Spring It also highlights forthcoming tax reforms relating to UK employee share schemes and residence and domicile laws, and provides an update on important European case law developments. Contents AT A GLANCE...1 EMPLOYMENT AND BENEFITS LAW UPDATE Statutory Compensation Limits Statutory Benefits Rates Income Tax and National Insurance Contributions Rates Pension Scheme Allowances Information and Consultation of Employees Regulations Pension Schemes Consultation Capital Gains Tax Reforms...2 Entrepreneurs Relief...3 Implications For Employee Share Schemes Changes to UK Residence and Domicile Laws...3 EUROPEAN CASE LAW Disability Discrimination by Association Holiday Pay and Sick Leave What Employers Should Be Doing Now...5 EMPLOYMENT AND BENEFITS LAW UPDATE 1. Statutory Compensation Limits The following increases apply to UK Employment Tribunal awards for claims with an appropriate date (normally, the employee s termination date) on or after 1 February 2008: the maximum compensatory award in most unfair dismissal claims has increased from 60,600 to 63,000; the maximum basic award in unfair dismissal claims, and the maximum statutory redundancy payment, have increased from 9,300 to 9,900; and the maximum gross weekly pay for calculating basic awards, statutory redundancy payments and other forms of statutory compensation has increased from 310 to Statutory Benefits Rates UK statutory benefit rates will increase on 6 April 2008 as follows: statutory maternity, paternity and adoption pay will increase from to per week (or 90% of normal weekly earnings, if lower); and statutory sick pay will increase from to per week. 3. Income Tax and National Insurance Contributions Rates the UK income tax personal allowance for people under 65 years old will increase from 5,225 to 5,435; 18 Offices Worldwide Paul, Hastings, Janofsky & Walker LLP

2 income tax rates will be amended. Currently the income tax rates are: starting rate (10%) 0 2,230; basic rate (22%) 2,231 34,600; higher rate (40%) over 34,600. From 6 April 2008, the starting rate of 10% will be abolished on earned income, and the basic rate will reduce from 22% to 20%. The income bands may also change but this will not be announced until the Budget Report in March 2008; and the national insurance contributions lower earnings limit for class 1 contributions will increase from 87 to 90 a week and the upper earnings limit from 670 to 770 a week. 4. Pension Scheme Allowances the UK pension scheme individual annual allowance in respect of scheme contributions will increase from 225,000 to 235,000 per annum; and the pension scheme individual lifetime allowance will increase from 1.6 million to 1.65 million. 5. Information and Consultation of Employees Regulations 2004 The Information and Consultation of Employees Regulations 2004 (the ICE Regulations ) apply to undertakings that carry out economic activity, whether or not for profit, and that have their registered or head office or principal place of business in Great Britain. When requested by a specified number of employees, the ICE Regulations require an employer subject to them to implement information and consultation agreements governing how it will consult with its workforce about economic and employment related issues. The ICE Regulations currently apply to UK undertakings with 100 or more employees. From 6 April 2008, the threshold will be reduced to 50 or more employees. Consultants, independent contractors and agency workers are not included in the calculation of employee numbers. 6. Pension Schemes Consultation The Occupational Pension Schemes (Consultation by Employers and Miscellaneous Amendment) Regulations 2006 (the Pension Consultation Regulations ) require UK employers to consult with employees prior to making specified changes to occupational and personal pension schemes. Specified changes include: changing the structure of the future accrual of members benefits from final salary to money purchase, excluding new members from joining schemes, reducing employer contributions to schemes, increasing member contributions and reducing the rate of future accrual of members benefits. The Pension Consultation Regulations do not apply to personal or stakeholder pension schemes to which the employer does not contribute. Currently, the Pension Consultation Regulations apply to undertakings with 100 or more employees. From April 2008, this threshold will be reduced to 50 or more employees. 7. Capital Gains Tax Reforms Capital gains tax ( CGT ) is currently payable in the UK by individuals, trustees and personal representatives on any gain made on the disposal of assets which are deemed to be chargeable assets. Such assets include certain shares acquired under employee share schemes. Each individual has an annual exempt amount upon which no CGT is levied in 2007/8, the first 9,200 of capital gains. After that, CGT is currently payable at 10%, 20% or 40%, determined by which income tax rate an individual falls within (see 3. above for a description of these rates). Taper relief reduces the amount of CGT payable, depending on the length of time an asset has been held and whether it is classified as a business or a nonbusiness asset. Gains on the disposal of business assets (which include shares in unlisted trading companies) are currently taxed at an effective rate of 10%, provided the asset has been held for at least two years. new flat rate of CGT at 18% will be introduced (eliminating the 10, 20 and 40% bands); taper relief will be abolished; the individual annual exempt amount for CGT will be retained; other features of the CGT regime will be abolished; 2

3 and a new entrepreneurs relief will be introduced. Entrepreneurs Relief The majority of the CGT reforms were announced in October Following widespread criticism, the new entrepreneurs relief was devised and announced. Draft legislation regarding the relief is not yet available. However, UK government press releases set out the general principles. Each employee shareholder will be eligible to obtain relief on up to 1 million of qualifying capital gains during his or her lifetime. Four ninths (approximately 44.5%) of any such qualifying capital gains will be exempt from CGT, resulting in an effective rate of 10% on the 1 million. Qualifying capital gains will include gains arising on disposal of shares or securities of a trading company if the individual has been an officer or employee of the company (or a group company) for at least one year and has held, for the same period, at least 5% of the ordinary share capital with at least 5% of the voting rights. Implications For Employee Share Schemes The full impact of the CGT reforms will only become apparent over time. However, some obvious effects are: the current tax benefits of Enterprise Management Incentive ( EMI ) options are likely to be significantly reduced. Currently, taper relief applies to EMI share options from the date of grant, and, provided shares are sold at least two years following the grant of the option, CGT is only 10% (even for higher rate taxpayers). After April 2008, CGT will generally be 18% on the disposal of EMI shares (unless the employee is able to claim entrepreneurs relief); Company Share Option Plans will be more taxefficient for employees if they dispose of their shares immediately after exercising options. Currently, if a higher rate taxpayer disposes of his or her shares immediately after exercise, he or she may pay CGT at 40%. Following the CGT changes, this will be 18%; the CGT changes may benefit holders of unapproved share options if they are higher rate taxpayers and dispose of their shares within one year of exercising their options. For higher rate taxpayers, the CGT rate would reduce from 40% to 18%. Additionally, if the option holder benefits from entrepreneurs relief, this rate would be further reduced to 10%; entrepreneurs relief may improve the tax treatment of shares or securities acquired under an employee share incentive scheme. However, because the employee must hold at least 5% of company voting rights, few will qualify for this relief, especially in relation to public listed companies or companies traded on any exchange; and with the abolition of taper relief, there will no longer be any tax incentive for employees to retain shares in their employing company after acquisition. 8. Changes To UK Residence And Domicile Laws Draft legislation amending the rules relating to residence and domicile was published on 18 January It was intended to take effect from 6 April 2008 and to give effect to the rules on residence and domicile announced in the UK Pre Budget Report on 9 October Issues of importance to resident nondomiciled individuals include: changes to the statutory test for residence; the 30,000 additional charge to non UK domiciled taxpayers; changes to taxation of non UK companies; and trust changes and distributions from non UK trusts. There is uncertainty regarding the final form and effect of the legislation, which is still being finalised. However, it will impact foreign employees working in the UK (especially US citizens, as it appears that the 30,000 additional charge may not qualify for US tax relief). It will also affect how remuneration packages are structured in relation to UK employees who work and are paid partially in the UK whilst also working in other jurisdictions under split or dual employment contracts. EUROPEAN CASE LAW 9. Disability Discrimination by Association In Coleman v Attridge Law and Law (C 303/06), a UK 3

4 employee filed a disability discrimination claim in the Employment Tribunal ( ET ), claiming that she suffered less favourable treatment than other employees on the grounds of her son s disability. The ET had to determine whether it was possible to bring a claim based on discrimination relating to her association with a disabled person ( Associated Disability Discrimination ) rather than discrimination relating to her own disability. The employee argued that the Equal Treatment Framework Directive (2000/78/EC) (the Directive ) prohibits Associated Disability Discrimination and, therefore, that the implementing UK legislation (the Disability Discrimination Act 1995, as amended (the DDA )) should be interpreted to comply with the Directive. When hearing disputes between private parties, UK courts must interpret national law as far as possible (without distorting its meaning) in a manner that ensures compliance with relevant European Union directives. If the court cannot interpret UK law to comply with a directive, UK law will prevail. However, if a UK law can reasonably be construed to conform to a relevant directive, a purposive construction will be applied even if it might involve some departure from the strict application of the UK law s wording. The ET decided that, on a literal interpretation, the DDA did not prohibit Associated Disability Discriminations. However, implying the words into the DDA necessary to prohibit Associated Disability Discrimination would be too bold a step without guidance from the European Court of Justice (the ECJ ). The ET therefore ordered the parties to agree to appropriate questions to be put to the ECJ. The employer appealed to the Employment Appeal Tribunal (the EAT ). The EAT held that the reference to the ECJ should go ahead to determine whether the DDA should be construed to prohibit Associated Disability Discrimination. The ECJ s decision is expected later in In the meantime, the Advocate General has opined that the Directive operates by reference to grounds of discrimination and that this does not depend on whether the discriminated against employee is him or herself disabled. Therefore, the Directive protects people from Associated Disability Discrimination. If the ECJ follows the Advocate General (as is usual), the EAT will have to consider whether to imply additional wording into the DDA to prohibit Associated Disability Discrimination. If it does, this will significantly expand the class of UK employees who can bring disability discrimination claims to include those who are treated less favourably in connection with their roles as carers. The same issue will arise in other EU countries that have not implemented the Directive in relation to Associated Disability Discrimination. 10. Holiday Pay and Sick Leave The EC Working Time Directive 93/104/EC (the Working Time Directive ) provides that EU Member States must ensure that workers are entitled to paid annual leave of at least four weeks, and that the minimum period of annual leave should not be replaced by payment in lieu (except where the employment relationship terminates). The UK Working Time Regulations 1998 implement the Working Time Directive. In Stringer and Others v Her Majesty s Revenue and Customs (C 520/06), the UK courts had to decide whether annual leave accrues when a worker is not working, so that a worker on long term sick leave (and not necessarily receiving any remuneration) could be paid for annual leave during that sick leave, and, on termination, could be paid for annual leave accrued but untaken during the sick leave period. The Court of Appeal held that a worker cannot take or accrue annual leave during a period in which he or she is absent from work on sick leave. Therefore, on termination of their engagement, a worker need not be paid in lieu of annual leave which would have accrued during the sick leave period. The case was referred to the highest UK court, the House of Lords, which referred questions to the ECJ. The ECJ has not yet heard the case but the Advocate General has delivered his opinion. He opined that, under the Working Time Directive, a worker can accrue (but not take) annual leave during sick leave, and, when an engagement terminates, the worker should receive payment in lieu of accrued but untaken annual leave for all or part of the year in question. If the ECJ follows this decision, workers on long term sick leave may be entitled to payment on termination for annual leave which has accrued during their sick leave. In extreme cases, this could amount to nearly 4

5 four weeks pay at the employee s normal rate. 11. What Employers Should Be Doing Now Where applicable, handbooks and written policies or procedures should be updated with the new benefit, tax and social security rates. Employees dealing with the administration of relevant benefits should be notified of the rate changes. Employers should check whether they will become subject to the ICE Regulations because of the new lower threshold. If so, employers may consider establishing voluntary workplace employee bodies as protective measures before the ICE Regulations apply, to forestall an employee request for representation under the legislation. A voluntary body can be more employer friendly than the mandatory arrangement under the ICE Regulations and may decrease the chances of employees later making a formal request for a representative body. Employers should also check whether they will fall within the scope of the Pension Consultation Regulations, following the amendments. If so, relevant consultation may be required prior to making any relevant changes to pension schemes. Employers should review the implications of the CGT reforms on their employee share schemes and, if appropriate, consider alternative methods of incentivising and retaining employees. HR personnel and in house lawyers should review UK and EU wide policies and practices that might give rise to potential cases of Associated Disability Discrimination and holiday accrual during sick leaves. Appropriate amendments can then be quickly made if required following the ECJ decisions. If you have any questions concerning these developing issues, please do not hesitate to contact the following Paul Hastings London lawyers: Chris Bracebridge chrisbracebridge@paulhastings.com Caroline Dunne carolinedunne@paulhastings.com Anna Sanford annasanford@paulhastings.com Christopher Walter christopherwalter@paulhastings.com 18 Offices Worldwide Paul, Hastings, Janofsky & Walker LLP StayCurrent is published solely for the interests of friends and clients of Paul, Hastings, Janofsky & Walker LLP and should in no way be relied upon or construed as legal advice. For specific information on recent developments or particular factual situations, the opinion of legal counsel should be sought. These materials may be considered ATTORNEY ADVERTISING in some jurisdictions. Paul Hastings is a limited liability partnership. Copyright 2008 Paul, Hastings, Janofsky & Walker LLP. IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations governing tax practice, you are hereby advised that any written tax advice contained herein or attached was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code. 5