Welcome to the latest edition of our Employee Incentives Update. The Update contains a round-up of key developments in this area during February and March 2016.
- Mandatory gender pay gap reporting – Government issues consultation on draft implementing regulations
- PIRC publishes UK Shareholder Voting Guidelines for 2016 AGM season
- HMRC issues spotlight on growth securities ownership plans and other tax avoidance schemes including contracts for differences
- HMRC issues new templates for share schemes annual returns for 2015/16 tax year and updated guidance notes together with new ERS Bulletin 22 outlining changes to the process for 2015/16
- Case law – First-tier Tribunal considers the tax treatment of a payment to compensate an employee for loss of certain contingent rights on a TUPE transfer
- Case law – Supreme Court allows HMRC's appeal in Deutsche Bank and UBS restricted securities schemes cases
- Case law - First-tier Tribunal considers that deferred shares form part of "ordinary share capital" and therefore the qualification requirements for entrepreneurs' relief were not met
- Prudential Regulation Authority (PRA) and the FCA announce that they will not apply CRD IV bonus cap to smaller firms
- Financial Conduct Authority (FCA) issues policy statement on implementing UCTIS V – including changes to guidance on payments in non-cash instruments
- The European Securities and Markets Authority (ESMA) has published its finalguidelines on sound remuneration policies under the UCITS Directive and AIFMD
- European Union and the USA government reaches agreement on data transfers – the new EU-US Privacy Shield will impact on US parent companies that operate plans for UK employees and/or where share plans are administered in the US
Mandatory gender pay gap reporting – Government issues consultation on draft implementing regulations
The Government has published its response to the consultation on the principles which will underpin the new gender pay gap reporting regime. Employers with 250 or more employees will have to publish: (i) mean and median overall pay gap figures (including bonus, commission, LTIPs and the cash value of shares); and (ii) mean bonus gap figures on an annual basis. In addition, affected employers must also publish the numbers of men and women paid across salary quartiles within their business and the proportion of men and women who received a bonus payment within a 12-month period. The response confirms that the regulations are likely to come into force on 1 October 2016, with a first reporting date of not later than 1 April 2018.
Further details and our analysis of the draft implementing regulations can be found here.
PIRC publishes UK Shareholder Voting Guidelines for 2016 AGM season
Pensions & Investment Research Consultants (PIRC) has revised its UK Shareholder Voting Guidelines for the 2016 AGM season. A number of changes have been made to the section on remuneration. In summary:
- the provision of remuneration consultancy by audit firms is wholly unacceptable;
- all individuals who attend remuneration committees should be disclosed and remuneration committee members should not be executive directors of other UK listed companies. From the 2016 AGM season onwards, PIRC will abstain on the election of any such directors who sit on the remuneration committee;
- using upside discretion when determining directors’ severance payments under incentive schemes should be forbidden by the remuneration committee; and
- the remuneration committee should be cautious in its application of “good leaver” status to a director on cessation of employment and this must be justified in the context of the company in the directors' remuneration report.
A copy of the Guidelines can be purchased from the PIRC website.
HMRC issues spotlight on growth securities ownership plans and other tax avoidance schemes including contracts for differences
HMRC has stated in Spotlight 28 that it is aware of a number of tax avoidance schemes including growth securities ownership plans, based on contracts for difference, thatpromoters claim entitle employees to capital gains treatment of the growth in value at the maturity of the contract.
The Spotlight states that many of these arrangements involve a financial instrument that entitles the employee to receive a cash payment at a specified date, provided a hurdle is achieved (which may be linked to company performance or other measures such as the disposal of the company). A common feature of all these schemes is that the employee pays a premium for entering into the arrangement and is exposed to a financial loss if results fall below a specified threshold. In reality, the downside risk is substantially less in cash terms than the potential upside and the likelihood of the downside risk being triggered is also much lower.
HMRC has reviewed a number of contracts for differences and it is their firm view that the schemes do not work and that any payments made by an employer to an employee on the maturity of the contract for difference should be taxed as employment income and subject to PAYE income tax and employer and employee National Insurance Contributions.
Spotlight 28 makes it clear that HMRC intend to "act swiftly and rigorously to challenge such cases".
It should be noted that the arrangements referred to in Spotlight 28 are not the same as growth shares or joint ownership arrangements, which may give capital gains tax treatment on the growth in value of the shares. These are not affected by this announcement.
HMRC issues new templates for share schemes annual returns for 2015/16 tax year together with updated guidance notes
HMRC has published updated versions of the annual return filing templates for all tax-advantaged and non tax-advantaged share schemes for the tax year 2015/16 along with brief guidance notes on completing each type of template. The annual return for 2015/16 must be submitted on or before 6 July 2016.
Links to the templates and guidance notes for Company Share Option Plans, Enterprise Management Incentives, Save As You Earn, Share Incentive Plans and other arrangements or schemes involving employment-related securities can be found here.
In addition, HMRC has published ERS Bulletin 22 (click here) which explains that theODS templates for the tax year 2014/2015 (version 2) will be withdrawn from today (6 April 2016). This means that if your Enterprise Management Incentives (EMI) or OTHER (Form 42) annual return for 2014/15 is still outstanding at 6 April 2016 you will need to use the templates provided for 2015/2016 tax year (version 3).
The Bulletin also explains that it will not be possible to submit annual returns using the new ODS templates for Company Share Option Plan (CSOP), Save As You Earn (SAYE) and Share Incentive Plan (SIP) for both 2014/2015 and 2015/2016 tax years until around the end of April 2016 and, if you are creating your own CSV files using the published technical guidance (which is recommended if you have more than 10,000 lines of data), these will not be accepted online until the end of May 2016.
Although, in the meantime, you can still check your CSV files for formatting errors using the Employment related securities (ERS) Checking Service at Employment related securities: check files and submit returns.
Case law – First-tier Tribunal considers the tax treatment of a payment to compensate an employee for loss of certain contingent rights on a TUPE transfer
In Reid v. Revenue & Customs Commissioners, the First-tier Tribunal found that the proportion of a buy-out payment to a former employee (Mr Reid) which was compensation for loss of pension expectations was not an emolument of his employment and was not taxable as earnings. It was a lump sum payment in lieu of a contingent right to additional pensions and, by virtue of the replacement principle, should be treated in the same way as the contingent right being replaced.
Mr Reid was employed by BP in a business that was transferred as a going concern to a new owner, North Air. Mr Reid's employment transferred to North Air under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). However, as the new owner's reward and benefit scheme was less generous than BP's, a lump sum compensation payment of £25,787 was paid to Mr Reid by BP. This was to compensate him for loss of pension, bonus and share rights and loss of lunch allowances.
Mr Reid treated this payment as falling within section 401 of ITEPA 2003 (and, as it was less than £30,000, therefore exempt from tax). However, HMRC determined that the whole buy-out payment was taxable as earnings as being from Mr Reid's employment. HMRC amended Mr Reid's self-assessment return and Mr Reid appealed to the First-tier Tribunal.
The First-tier Tribunal allowed the appeal in part finding that there was no evidence that the payment was made as an inducement to enter into employment with the new owner or to accept different terms of employment. The tribunal also rejected HMRC's submission that the conditions set out in the compromise agreement were sufficient to make the payment an emolument of employment.
The "replacement principle" set out in Maris v Haughty provides that the character of a payment which is made in satisfaction of or to replace a contingent right to another payment is generally treated in the same way as that contingent right. In this case, the part of the appeal which related to the compensation for the loss of expectation of pension rights could be paid tax free but the part of the compensation that was for the loss of the other elements (bonus, share rights and lunch allowance) was subject to tax. Although in the case of the loss of share rights, this was in the main part due to the fact that Mr Reid produced no evidence that the underlying rights would have been free from income tax, for example as the shares were provided under a tax-advantaged share scheme and, in the absence of such evidence, the Tribunal considered that they had to find that this element was taxable.
Reid v. Revenue & Customs Commissioners  UKFTT 0079 (TC),
Mairs v Haughey  1 AC 303
Case law – Supreme Court allows HMRC's appeal in Deutsche Bank and UBS restricted securities schemes cases
The Supreme Court has overturned the Court of Appeal decisions in the Deutsche Bank and UBS restricted securities scheme cases, finding in favour of HMRC. The Supreme Court applied a purposive approach to the relevant legislation and found that the securities used in the tax avoidance schemes implemented by Deutsche Bank and UBS were not "restricted" and did not therefore fall to be taxed under chapter 2 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA). Instead, employees received an award of shares which should have been taxed under the general earnings provisions in section 62 of ITEPA.
The schemes purported to utilise a concession in section 425 of ITEPA which provides that where there is an award of securities that (i) are subject to various restrictions which reduce their market value, (ii) include a provision for the forfeiture of the restricted securities and (ii) provide that on such forfeiture the employee will receive less than the unrestricted market value, no income tax will arise on the acquisition of the restricted securities. The schemes also purported to utilise a concession in section 429 of ITEPA which provides that there is no income tax charge on an otherwise taxable event in certain circumstances.
The Supreme Court considered that the context of Chapter 2 of ITEPA indicated that its intention was to counteract opportunities for tax avoidance and that "viewed from a commercially realistic perspective" the shares were not restricted securities as the restrictions had no "business or commercial purpose" but instead were "commercially irrelevant conditions whose only purpose [was] the obtaining of the exemption".
This decision gives a clear indication that the judicial view of tax avoidance arrangements is shifting such that if tax avoidance is the main purpose of the arrangement, and that cannot (in the court's view) have been the intention of Parliament, then the court should apply a purposive interpretation of the legislation meaning that the arrangement will fail.
A copy of the combined judgment can be found here.
Case law - First-tier Tribunal considers that deferred shares form part of "ordinary share capital" and therefore the qualification requirements for entrepreneurs' relief (ER) were not met
The First-tier Tribunal has determined that a director did not qualify for ER (whereby capital gains on shares are taxed at 10%) as his holding of shares only came to 4.99% of the total ordinary share capital (rather than the required 5%) once the deferred shares in the company had been included. The deferred shares had no voting rights, dividend entitlement or entitlement to a distribution on winding up and the company had therefore not included them in the total ordinary share capital of the company. However, the First-tier Tribunal found that the wording of section 899 of the Income Tax Act 2007 was clear that "all the company's issued share capital (however described)" should be counted towards the total ordinary share capital for the purposes of the shareholding requirements for ER.
Companies which have deferred shares should therefore ensure that these are included in the total ordinary share capital of the company when considering the availability of ER in respect for shareholdings of employees and directors.
A copy of the judgment can be found here.
The PRA and the FCA announce that they will not apply CRD IV bonus cap to smaller firms
The PRA and the FCA have released a joint statement on compliance with the European Banking Authority (EBA) guidelines on Sound Remuneration Policies (EBA Guidelines). The statement provides that the PRA and the FCA have notified the EBA that, in their capacity as regulators, they will comply with all aspects of the EBA Guidelines, except for the provision that the limit on awarding variable remuneration to 100% of fixed remuneration, or 200% with shareholder approval (bonus cap), must be applied to all firmssubject to the Capital Requirements Directive (CRD).
The approach to the bonus cap under the EBA Guidelines represents an interpretation of CRD with which neither the PRA nor the FCA agree. The PRA and FCA state that they take a proportionate, risk-based approach to applying the bonus cap based on the wording under Article 92(2) CRD, which states: “competent authorities shall ensure that … institutions comply with the following principles [including the bonus cap] in a manner and to the extent that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities”.
The PRA and the FCA take the view that the “extent” of application in a proportionate manner may include not applying a remuneration principle in its entirety based on the size, internal organisation and the nature, scope and complexity of the activities of the firm in question. The PRA and FCA consider that the CRD proportionality principle applies equally to all numerical requirements, including the bonus cap, deferral, payment in instruments, and ex-post risk adjustment.
The PRA and the FCA are therefore retaining their current approach of requiring smaller firms to determine an appropriate ratio between fixed and variable remuneration for their business while not applying the bonus cap. The bonus cap will continue to apply to all large and systematically important UK CRD IV firms.
A copy of joint statement can be found here.
The FCA issues policy statement on implementing UCTIS V – including changes to guidance on payments in non-cash instruments
In Policy Statement (PS) 16/2, the FCA sets out Handbook changes affecting managers and depositaries of UCITS and alternative investment funds. These changes mainly relate to final rules and guidance for implementing UCITS V and include changes to the guidance on payments in non-cash instruments.
The PS also sets out the FCA's response to the feedback on Part I of Consultation Paper (CP) 15/27 “UCITS V Implementation and other changes to the Handbook affecting investment funds”. In Part I of the CP the FCA consulted on proposed rules and guidance for implementing UCITS V requirements, including the requirements applicable to the remuneration principles.
A copy of the PS can be found here.
ESMA publishes remuneration guidelines
ESMA has published its final guidelines on sound remuneration policies under the UCITS Directive and AIFMD (Guidelines). It has also written to the European Commission, European Council and European Parliament on the proportionality principle and remuneration rules in the financial sector. The accompanying press release (ref 2016/472) highlights the key issues, particularly in the area of proportionality. The Guidelines apply from 1 January 2017.
The Guidelines will now be translated into the official languages of the European Union and the final texts published on the ESMA website. The deadline for compliance notifications will be two months after the publication of the translations.
European Union and the USA government reach agreement on data transfers
You may recall that in October 2015 the Safe Harbour framework for the flow of personal data between the USA and EU countries was declared invalid by the Court of Justice of the European Union. The European Commission and the United States have now agreed a new protocol for transfers of personal data, to be known as the EU-US Privacy Shield.
The new EU-US Privacy Shield is important for US parent companies that operate plans for UK employees and/or where share plans are administered in the US. It provides stronger obligations on companies in the US to protect the personal data of Europeans and stronger monitoring and enforcement by the US Department of Commerce and Federal Trade Commission, including through increased cooperation with European Data Protection Authorities. The new arrangement includes commitments by the US that the ability under US law for public authorities to access personal data transferred under the new arrangement will be subject to clear conditions, limitations and oversight, preventing generalised access. Europeans will be able to raise any enquiry or complaint in this context with a dedicated new Ombudsman.