Employee Benefits News

Employee Benefits News October 2011 Employee Benefits News Executive remuneration: new consultations and revised ABI guidelines Consultation on enhanced disclosure and "say on pay" proposals The Business Secretary, Vince Cable, has long been recognised as a high profile critic of (some aspects of) executive remuneration in the UK. He has made a number of speeches touching on the subject, in which he has highlighted the apparent disconnect between increasing levels of executive pay and company performance, together with perceived weaknesses in the UK corporate governance regime. It therefore came as no surprise when the Department for Business Innovation and Skills (BIS) finally published its proposals on executive remuneration on 19 September 2011. BIS has published two documents: a discussion paper seeking views on a range of issues relating to executive remuneration; and a separate consultation paper on company reporting, which includes a number of proposals to make the reporting of executive remuneration "clearer and more relevant to investors". Contents Executive remuneration: new consultations and revised ABI guidelines What issues remain as the dust begins to settle on the "disguised remuneration" (DR) legislation? New rules for EFRBS and corporation tax deductions Office of Tax Simplification: a new dawn for tax-approved share plans? EU Prospectus Directive: update on changes for companies offering employee share plans Employee Benefits Seminar: a date for your diary Discussion paper In the discussion paper BIS invites views on a number of wide-ranging ideas which are aimed at ensuring accountability for, and simplification of, executive pay. These include: making the shareholders' vote on executive pay "binding"; and making changes to the composition of remuneration committees (RemCos) to include employee representatives (or alternatively, allowing an advisory "employee vote" on remuneration proposals for directors). It is unclear whether any of these ideas will in due course become binding on UK companies and no timetable has been set for their possible implementation. Some of the ideas give rise to obvious legal and/or practical difficulties (e.g. would an executive be willing to change jobs if the terms of his new appointment could later be voted down by shareholders) and will no doubt generate a wide range of responses from interested parties. Consultation paper Under the consultation on company reporting, BIS is proposing to replace the current Business Review and Directors' Report for listed companies with a "Strategic Report" and "Annual Directors' Statement". The Strategic Report would contain key remuneration data, including a single figure for the total remuneration of each director and the link between pay and performance. The full remuneration report would still be required as part of the "Annual Directors' Statement". Further suggestions include: If you would like to know more about the subjects covered in this publication or our services, please contact: Kevin Thompson +44 (0)20 7006 8930 Robin Tremaine +44 (0)20 7006 8933 Daniel Hepburn +44 (0)20 7006 4467 Sonia Gilbert +44 (0)20 7006 2041 Editor Sally Robinson +44 (0)20 7006 8361 To email one of the above, please use firstname.lastname@cliffordchance.com Clifford Chance LLP, 10 Upper Bank Street, London, E14 5JJ, UK

Employee Benefits News 2 remuneration disclosure being extended to certain "senior managers" who have a significant influence over the success of the company; and disclosure of pay ratios (between the chief executive's earnings and the median earnings of the workforce as a whole). Please click here for a client briefing containing more details on the proposals Executive Remuneration Briefing. The proposed changes to the disclosure of executive remuneration will apply to all quoted companies and will come into effect for reporting periods falling on or after 1 October 2012. These changes are therefore much more "real" than the ideas put forward in the discussion paper. In both cases BIS is seeking feedback by 25 November 2011. If you have any comments on the proposals that you would like to discuss with us, please do get in touch. We would be very happy to include your thoughts (on a named or no-names basis) in the responses which we will be making. Revised ABI guidelines September was a busy month in the world of executive remuneration, with publication of the revised ABI guidelines on 29 September 2011 coming hot on the heels of the BIS proposals. The revised ABI guidelines generated much broadsheet interest, although in reality they represent a change in emphasis, with a greater focus on key concerns of topical interest, rather than wholesale change. Helpfully, the revised ABI guidelines have become less prescriptive, with a "principle-based" approach and greater scope for RemCos to develop remuneration structures based on the particular circumstances of the company. A copy of the updated ABI guidelines can be accessed here http://www.ivis.co.uk/executiveremuneration.aspx. BIS has welcomed the revised ABI guidelines, on the basis that the key principles in the guidelines are based on the premise that excellent performance should be rewarded but that there is also a strong need to end "reward for failure". Detailed guidance on employee share plans There is little that is new in the detailed guidance relating to the structure of employee share plans. However, the ABI have now incorporated comments on taxation. The ABI guidelines now state that RemCos should not seek to make changes to any element of executive remuneration to compensate participants for changes in their personal tax status. According to the guidelines, remuneration structures that seek to "increase tax efficiency" should not result in additional costs to the company or an increase in its own tax bill. In addition, RemCos should be aware of the potential damage to the company's and shareholders' reputation from implementing tax-based schemes. Performance conditions As regards performance conditions, the ABI note that shareholders have a "strong and clear" preference for financial metrics and that where any non-financial metric is used it should be quantifiable and linked to value equation and disclosed. The ABI guidelines are also now explicit that RemCos should satisfy themselves that even if performance conditions have been met for long term incentives, this should not produce outcomes which are not in line with the overall performance of the company. The guidelines also still say that, where TSR is used as a performance measure, the RemCo should satisfy itself that TSR performance is a genuine reflection of the company's underlying performance and the RemCo's reasoning should be explained to shareholders. Hot topics The revised guidelines also pick up on a number of themes that have been widely trailed in the press and which have also been a matter of particular focus/additional regulation in the financial services sector. These include: a greater emphasis on shareholders being concerned with the quantum of remuneration (and not just its structure) - the RemCo has a responsibility to assess the appropriateness of changes in the quantum of reward in the context of the company overall, including changes in employee remuneration more broadly; and in the context of annual bonuses, the guidance is now clearer that payment is to be discouraged if the business has suffered an exceptional negative event, even if the specific targets have been met. The ABI also note that deferring a

Employee Benefits News 3 portion of a bonus into shares can create greater alignment with shareholders but qualify this by also stating that it should not result in an increase in the overall quantum of the bonus. Query what that means in the context of providing matching shares alongside deferred bonus shares. Other comments of interest include: if share prices fall substantially then new grants should be scaled back to avoid windfall gains. the RemCo may have a role to play in determining pay or having an oversight at below board level, particularly where the remuneration or risks are material. If the revised guidelines seem to affect your share incentive plans, please contact us. We can discuss how best to react to the guidelines (e.g. by making minimal changes to the plans that should not need shareholder approval). What issues remain as the dust begins to settle on the "disguised remuneration" (DR) legislation? In brief The DR legislation received Royal Assent on 19 July 2011 and HMRC then published draft guidance on the DR legislation (DR guidance) in August. In addition, draft regulations on the "equivalent" NIC provisions for DR were published for comment on 26 August 2011. (The DR legislation for income tax generally applies to "relevant steps" on or after 6 April 2011, although the equivalent NIC provisions will only apply to relevant steps taken after the NIC regulations are enacted). There is now much greater certainty regarding the intended scope of the DR legislation and also the areas where HMRC are prepared to be helpful in the interpretation of its provisions. That said, some "sticking points" remain, particularly in the context of the "earmarking" exclusions for employee share plans/deferred remuneration. There are also particular issues to be aware of in the context of, amongst other things, employer-financed retirement benefits schemes (EFRBS) although (with some careful planning) these issues should not be insurmountable. "Earmarking": helpful HMRC guidance In the latest draft DR guidance published on 18 August 2011, HMRC re-confirmed their view on what will and will not constitute "earmarking" under the DR legislation in the context of hedging arrangements for employee share plans (i.e. where shares are held in an EBT to satisfy awards granted by a company to its employees and directors). In general, there will be no earmarking where the EBT trustee has not granted the awards to employees and does not know the names of the employees to whom the awards have been granted ("blind earmarking"). Ultimately, it will be a question of fact as to whether or not the EBT trustee knows the names of the relevant employees. HMRC have stated that they will consider the "genuineness" of arrangements where there appears to be a "manipulation of an apparent lack of knowledge" on the part of the EBT trustee. However, in most circumstances, the blind earmarking approach gives us a relatively easy "fix" to ensure that conventional employee share plans operated in conjunction with EBTs are not caught by DR. Therefore, if you use an EBT to satisfy share plan awards, the relevant arrangements between you and the EBT trustee should be reviewed and amended before you next use the EBT to avoid any earmarking taking place. By using blind earmarking, companies can avoid having to rely on one of the earmarking exclusions in the DR legislation which are specifically designed for employee share plans and/or deferred remuneration. These exclusions are complex and some share plan rules will require amendment to fall within their terms. Moreover, even if a DR tax charge is avoided at the initial earmarking stage, a "fall-back" DR tax charge may inadvertently be triggered at a later point if the relevant conditions within the exclusion are not met. Of course, there may be some limited circumstances in which it is not possible to rely on the blind earmarking approach (for example, where the EBT trustee grants the awards). In such circumstances it will be necessary to rely on one of the exclusions and we can help you to do this. Please contact us for further details. EFRBS The treatment of EFRBS under the DR legislation has been a moving feast, particularly in the context of internationally mobile employees. One of the policy objectives of the DR legislation is to "catch" EFRBS and therefore making further contributions

Employee Benefits News 4 into EFRBS is now unattractive from a tax perspective. However, the final version of the DR legislation is more favourable as regards EFRBS distributions and now contains some helpful exclusions. The DR legislation provides that the current UK tax rules applying to foreign pensions (i.e. pensions provided from an offshore EFRBS) take priority over the DR taxing rules. Therefore, a UK-resident/non-dom receiving a foreign pension should continue to be taxed only on the remittance basis (and a UK-resident/UK-dom on only 90% of the foreign pension). This is good news. However, different considerations may apply in the case of EFRBS participants who are non-resident by the time they receive pension payments; in their case it may be necessary to rely on other exclusions within the DR legislation. If this is relevant to you, please contact us for advice. This is a complex area. Non-taxable payments/benefits Careful planning may also be required in the context of certain payments which you would not ordinarily expect to be taxed. For example, termination payments of up to 30,000 are not taxable under normal income tax rules but there is no equivalent exemption under the DR legislation. Therefore such payments may be subject to a DR tax charge if they are made by a trustee or other "relevant third person". New rules for EFRBS and corporation tax (CT) deductions The Finance Act 2011 (under which the DR legislation was enacted) has altered the CT deduction rules for contributions into EFRBS. This change is in addition to the changes it has made to the CT rules to take account of DR. Under the change (which applies from 6 April 2011), no CT deduction is allowed in respect of a contribution to an EFRBS unless and until a payment or transfer is made out of the EFRBS which "gives rise" to an employment income tax charge under the normal income tax rules for EFRBS or pension payments (previously it was sufficient that the payment/transfer was being made out of an EFRBS, regardless of the tax treatment). On the face of it this may seem problematic in the case of payments/transfers to certain internationally mobile employees, where the intention is that they will not be subject to tax under either the EFRBS or pensions tax rules (or only subject to tax on the remittance basis). However, we believe that there should still be opportunities to generate CT deductions in these circumstances. Please contact us for further details. Office of Tax Simplification: a new dawn for tax-approved share plans? The Office of Tax Simplification (OTS) has been charged by the Government with reviewing the tax treatment of employee share plans. The existing tax rules are viewed by the Government as being particularly complex, leading to unnecessary administrative burdens for employers. The OTS will carry out a two-part project, focussing initially on tax-approved plans and then considering unapproved plans. The project will also encompass, amongst other things, consideration of the existing accounting treatment of employee share plans. The OTS is aiming to produce a report and recommendations on approved share plans "in time for" Budget 2012 (the date of which is yet to be announced) before looking at unapproved share plans. The OTS will be consulting with interested parties and has formed a consultative committee. We will be feeding in our comments to committee members and so please do let us have your feedback about any tax-related problems that you have faced in running your approved share plans. EU Prospectus Directive (EU PD): update on changes for companies offering employee share plans In our April 2011 newsletter we reported that a number of favourable changes had been made to the EU PD which should assist companies operating employee share plans. Member States have until 1 July 2012 to implement the changes. Two of these general changes to the EU PD exclusions/exemptions, which companies may use for employee share plans, have already been implemented in the UK, as from 31 July 2011: the exemption which applies to offers made to fewer than 100 individuals per member state has been increased to fewer than 150 individuals per member state; and

Employee Benefits News 5 the exclusion which applies where the consideration for the offer over a period of 12 months is less than Euro 2.5 million (across the EU) has been increased to less than Euro 5 million (across the EU). Early implementation in the UK is very helpful, although companies making multi-jurisdictional offers in the EU will still need to consider the relevant limits in the other EU states i.e. where other states have not implemented the changes as quickly as in the UK. Unfortunately, the UK has not yet implemented the changes to the scope of the specific employee share plans exemption. (These changes will mean that the exemption is extended to all companies whose head office or registered office is in the EU (regardless of whether or not they are listed). In addition, companies which are "established" outside the EU will qualify for the exemption if they are listed on an EU regulated market (as is the case under the original exemption wording) or if they are listed on a "third country market" which has been approved by the EU Commission). There is currently no indication that these changes will be implemented prior to 1 July 2012. We are lobbying, through ifsproshare, for these changes to be implemented as soon as possible so that a wider variety of both EU and non-eu companies can take advantage of the employee share plans exemption. Employee Benefits seminar: a date for your diary We are delighted to announce that our annual client seminar will be taking place on 7 December 2011. Invitations will be sent out shortly and we very much hope that you will be able to join us. This Client briefing does not necessarily deal with every important topic or cover every aspect of the topics with which it deals. It is not designed to provide legal or other advice. If you do not wish to receive further information from Clifford Chance about events or legal developments which we believe may be of interest to you, please either send an email to nomorecontact@cliffordchance.com or by post at Clifford Chance LLP, 10 Upper Bank Street, Canary Wharf, London E14 5JJ. www.cliffordchance.com Clifford Chance LLP is a limited liability partnership registered in England and Wales under number OC323571. Registered office: 10 Upper Bank Street, London, E14 5JJ We use the word 'partner' to refer to a member of Clifford Chance LLP, or an employee or consultant with equivalent standing and qualifications.