Incentive compensation

Typical structures

What are the prevalent types and structures of incentive compensation? Do they vary by level or type of organisation?

Considering the current international corporate environment, types and structures of incentive compensation must be designed according to a global compensation scheme.

Each company designs its global compensation scheme to attract talent and retain it according to its sector of activity, size and life cycle. Big listed companies may design share-based incentives for their executives aligned with the shareholders’ interests, and on the other side a start-up company may address its incentives with the achievement of the highest selling price of the company in mind.

In any case, and following proxy advisers’ recommendations, the common practice on incentive compensation is to establish short and long-term schemes of variable compensation, to link it to the achievement of specific financial and non-financial targets and to limit the amount of the variable compensation to a certain percentage of the fixed remuneration.

Restrictions

Are there limits generally on the amount or structure of incentive compensation? Are there limits that adversely affect the tax treatment of the compensation relative to the employer or the executive?

As a general rule, according to the Workers’ Statute, the total amount of annual remuneration that an employee can receive in kind for all concepts cannot exceed 30 per cent of his or her total annual remuneration (ie, fixed and variable remuneration).

In addition, for certain sectors, there is a specific regulation that imposes restrictions on the remuneration satisficed to certain employees and executives of companies operating in those sectors. Among others, entities affected by these specific provisions are as follows:

  • credit institutions;
  • management companies of collective investment institutions;
  • management companies of closed-end investment companies; and
  • insurance companies.

 

These limits mainly affect the following:

  • the determination and form of payment of the variable remuneration approved (ie, clauses malus and clawback);
  • the design and payment of social security insurance; and
  • the limits and form of reimbursement of severance payments.

 

For instance, the law on management, supervision and solvency of credit institutions (Law No. 10/2014) establishes for certain key employees of the company that the variable component shall not exceed 100 per cent of the fixed component of their total remuneration (it can reach 200 per cent in the case of approval by the shareholders’ meeting).

From a tax point of view, the main limits are applicable on severance payments. Costs derived from the remuneration paid to employees and executives are deductible for the employer for Spanish corporate tax (SCT) purposes as long as the below criteria are met, as follows:

  • the accounting expense borne by the employer is linked to an activity effectively performed in favour of the employer;
  • if applicable, the approval procedure settled by corporate legislation has been followed; and
  • transfer pricing formal requirements are fulfilled.

 

The deductible amount is limited to the obligatory amount established in the Workers’ Statute, with the limit of €1 million.

In addition, the Personal Income Tax Law (PIT Law) establishes that indemnities for worker dismissal or severance payments derived from the termination of ordinary employment contracts can be exempt from taxation in the obligatory amount established in the Workers’ Statute, with the limit of €180,000.

Deferral

Is deferral and vesting of incentive awards permissible? Are there limits on the length or type of vesting and deferral provisions?

Deferral and vesting of incentive awards are permissible according to the relevant Spanish laws.

There are the usual recommendations of proxy advisers who are establishing standards in various aspects of corporate governance in relation to remuneration of directors and senior management, such as in respect to vesting periods. The most recent recommendations have advised that the minimum vesting period should be no less than three years from the grant date.

In addition, and for financial entities, Law No. 10/2014 establishes that at least 40 per cent of the variable remuneration must be deferred over a period that is not less than three to five years. The deferred amount should be 60 per cent in the case of significantly large amounts of variable remuneration.

Are there limitations on the individuals or groups eligible to receive the compensation? Are there aspects of the arrangement that can only be extended to certain groups of employees?

In addition to the main legal limitations, Spanish companies tend to follow the recommendations of the Good Governance Code, which are in line with proxy advisers’ recommendations.

The Good Governance Code proposes some restrictions for variable remunerations of directors, among others:

  • shares granted to non-executive directors should be retained until the end of their mandate;
  • variable remuneration items should be subject to predetermined and measurable performance criteria that factor the risk assumed to obtain a given outcome and promote the long-term sustainability of the company and include nonfinancial criteria that are relevant for the company’s long-term value creation;
  • companies should consider establishing a reduction clause (‘malus’) based on deferral for a sufficient period of the payment of part of the variable component;
  • variable remuneration components should be deferred (for not less than three years). For clarification, that means that following the award of shares, options or financial instruments corresponding to the remuneration schemes, executive directors should not be able to transfer their ownership or exercise them until a period of at least three years has elapsed, save for those executive directors that maintain a number of shares equivalent to twice their annual fixed remuneration;
  • a major part of executive directors’ variable remuneration should be linked to the award of shares; and
  • termination payments to directors should not exceed a fixed amount equivalent to two years of their total annual remuneration.
Recurrent discretionary incentives

Can it be held that recurrent discretionary incentive compensation has become a mandatory contractual entitlement? Is this rebuttable?

There are some circumstances under which, in principle, discretionary incentive compensation could be construed as consolidated contractual obligations before courts. For example, if the company pays the workers the same amount for this ‘discretionary incentive’ every year or if the company does not establish an objective and transparent criteria for the calculation of the incentive, workers could claim for it to be considered a consolidated right and, hence, a mandatory contractual obligation. A court must decide whether the continued grant of the same benefit entails that it has been considered as a consolidated right.

Effect on other employees

Does the type or amount of incentive compensation awarded to an executive potentially affect the compensation that must be awarded to other executives or employees?

Even though there could be some differences whenever it could be objectively justifiable, the scheme should respect, in any event, equality and non-discrimination principles. It is recommended that objective criteria are used and are applied to all executives of the same category and holding the same status. In this regard, two Royal Decrees (901/2020 and 902/2020, of 13 October 2020) aim to guarantee (1) equal pay for employment of equal value and (2) the effectiveness of equality plans (regulated by Organic Law 3/2007, of 22 March 2007).

Mandatory payment

Is it permissible to require repayment of incentive compensation under certain circumstances? Are there circumstances under which such repayment is mandatory?

Employers in Spain, as a general principle, cannot claim the repayment of any salary item, unless it can be proved that there was a mistake in the payment to a specific worker (the amount actually was not due). The aforementioned is different to the following:

  • a circumstance in which the payment has the nature of an advanced payment on account of the final vested amount, regulated as such; and
  • the application of clawback clauses to executives regarding their variable remuneration.

Can an arrangement provide that payment is conditioned on continuing employment until the payment date? Are there exceptions?

In principle, payments of variable remuneration can be conditional on the employee remaining until the date of payment.

However, whenever termination is decided by the employer with no cause (unfair dismissal) some case law understands that the payment is due, since it is considered that the worker would have been deprived of a right by an ungrounded unilateral decision of the company. This could constitute a breach of section 1256 of the Civil Code, which forbids the performance of the contract being left up to the discretion of one of the parties (the employer). Additionally, the clause could be unenforceable if the performance period of accrual of the payment has concluded when termination takes place.