Welcome to the latest edition of our Employee Incentives Update.  The Update contains a round-up of key developments in this area during January 2016. 

In summary:

FINANCIAL SERVICES

  • Prudential Regulation Authority (PRA) publishes consultation paper on Buy-outs of Variable Remuneration

CORPORATE GOVERNANCE

  • Financial Reporting Council (FRC) publishes report on Developments in Corporate Governance and Stewardship 2015

TAX

  • Taxation of discrimination payments and awards – Upper Tribunal finds payment for injury to feelings for discrimination arising out of the termination of employment taxable under section 401 Income Tax (Earnings & Pensions) Act 2003 (ITEPA)  
  • HMRC announces that the informal post-transaction valuation check (PTVC) and PAYE healthcheck service offered by HMRC Shares and Assets Valuation will cease on 31 March 2016

In full:

FINANCIAL SERVICES

PRA publishes a Consultation Paper on Buy-outs of Variable Remuneration

The PRA's consultation paper (CP2/16) proposes a model that allows for the possibility of malus and clawback to be applied to buy-out awards made by the new employer based on a determination by the old employer.  The PRA considers that the practice of the new employer buying out the deferred bonus awards that have been cancelled by the former employer on termination of employment undermines the effectiveness of malus and clawback as employees are able to "insulate" themselves against ex-post risk adjustment of their past awards.

The proposed rule would apply to all material risk takers at PRA-regulated banks, building societies and designated investment firms – although, on proportionality grounds, it would not apply to firms in Level 3 of the proportionality framework.

In summary:

  • The proposed rule would require the old employer to notify the new employer of any determination of malus or clawback which resulted from misconduct or failures of risk management at the old employer which were attributable to the former employee. The new employer would be required to act on that determination in respect of the buy-out award and withhold or clawback the appropriate amount from the award.
  • The old employer would be under a duty to act fairly and reasonably in making any such determination backed up by a new private right of action for damages in the event of a failure by a firm to comply with the rule. 
  • The old employer would be required to provide the former employee with details and reasons for any proposed malus or clawback and allow the former employee to make representations as to why any such determination should not be made.  The old employer must take these into account when making its final determination.
  • There would be scope for the new employer to apply for a waiver where it had reason to believe the old employer's decision to apply malus or clawback had been manifestly unfair or unreasonable.

The consultation period closes on 13 April 2016.  The FCA has stated that it will not consult alongside the PRA at this stage but will closely follow feedback to this consultation and any subsequent changes proposed by the PRA and will consider its position at a later stage.

A copy of the consultation paper can be found here.

CORPORATE GOVERNANCE

FRC publishes its report on Developments in Corporate Governance and Stewardship 2015

The overall quality of corporate governance in the UK remains high according to the FRC's Developments in Corporate Governance and Stewardship 2015 report published during January 2016.

Of particular note:

  • Overall levels of compliance with the UK Corporate Governance Code remain high with 90 per cent of the FTSE 350 complying with all but 1 or 2 provisions.
  • Board succession planning remains key. The FRC will be following up on its recent discussion paper in 2016.
  • While there has been very good progress on reporting of boardroom gender diversity policies, the FRC note that a disappointing number of companies make no reference to the broader concept of diversity including race and experience.
  • In the FTSE 100 there has been an increase from 37 per cent (2014) to 51 per cent (2015) of companies having longer share retention periods with regards to remuneration.
  • Long term share awards can be clawed back in 70% of FTSE 100 companies.
  • Malus can be applied to LTIP awards in 84% of FTSE 100 companies.
  • The number of FTSE 350 companies whose remuneration policy was voted against by 20% or more of shareholders fell from thirteen (2014) to four (2015).

A copy of the report can be found here.

TAX

Taxation of discrimination payments and awards

There has been conflicting case law on whether or not a payment for injury to feelings fordiscrimination arising out of the termination of employment is taxable. 

In the most recent decision (Moorthy v Revenue & Customs), the Upper Tribunal agreed with HMRC's view that a payment for injury to feelings which arises out of the termination falls to be taxed under section 401 ITEPA (i.e. broadly, that any amount over £30,000 is subject to income tax in full).  The Upper Tribunal in Moorthy considered that the previous case of Oti-Obihara v HMRC, which held that if discrimination is the cause of the termination of employment, any payment made in respect of the discrimination is taxable only to the extent that it is for financial loss caused by the termination of employment, had been wrongly decided.  Instead, the Upper Tribunal stated that the only question is whether there is a connection between the payment and termination. If there is, the payment is caught by section 401 ITEPA. If there is not, the payment will not be caught by section 401 - whether the payment relates to financial loss or not is irrelevant for this purpose.

Similarly, the Upper Tribunal in Moorthy rejected the view of the Employment Appeal Tribunal in both Orthet Ltd v Vince-Cain (2) and Timothy James Consulting Ltd v Wiltonthat the reference to "injury" in Section 416 ITEPA (under which payments can be paid free of tax without limitation) included awards for injury to feelings in discrimination cases. The Upper Tribunal determined that injury, like disability (also referred to in section 416 ITEPA), means a medical condition that results in the termination of employment. Accordingly, it found that the injury to feelings award was a taxable termination payment.

It is worth noting that where the payment relates to injury to feelings and the discrimination giving rise to the payment is not related to the termination of employment, it should still be capable of being paid tax free.

A copy of the judgment in Moorthy can be found here

HMRC announces that the informal post-transaction valuation check (PTVC) and PAYE healthcheck service will cease on 31 March 2016

The informal post-transaction valuation check (PTVC) and PAYE healthcheck service currently offered by HMRC Shares and Assets Valuation (SAV) will cease on 31 March 2016. Any PTVC or PAYE healthcheck requests received after this date will not be processed.  HMRC has stated that the withdrawal of this service is because of pressure on SAV's resources and, in future, tax valuations will be identified for enquiry using a risk-based approach.

Whilst valuations for tax-advantaged schemes (CSOPs, SAYE option schemes, SIPs and EMIs) and employee shareholder status valuations will continue, HMRC is reviewing their operation to see if these services can be improved. CGT valuation checks will continue as normal.

The withdrawal of the PTVC service will have particular impact on those companies that operate non tax-advantaged employee share incentive arrangements such as growth shares or joint ownership arrangements.  In these cases, the ability to obtain informal HMRC approval of the share valuation following the award gave companies and participants comfort regarding their future tax position.