Welcome back to our Employee Incentives Update, after a short break our monthly Update is up and running again. We hope you find it useful. This Update contains a round-up of key developments in remuneration during January 2017.

In summary:

Tax

  • Operating clawback in practice – HMRC issues guidance on tax position

Corporate Governance

  • High Pay Centre highlights pay differentials between CEOs in FTSE 100 companies and the average UK salary in its "Fat Cat Wednesday" campaign
  • Financial Reporting Council publishes it report on the implementation of the UK Corporate Governance and Stewardship Codes during 2016
  • The Pensions and Lifetime Savings Association publishes it new Corporate Governance Policy and Voting Guidelines 2017 calling for more accountability over executive pay
  • The world's largest asset manager, Blackrock, urges companies to rein in executive pay in letter to FTSE 350 boards
  • The European Securities and Markets Authority clarifies how options should be valued for the purpose of the EUR 5,000 disclosure threshold under the Market Abuse Regulation

In full:

Tax

Operating clawback in practice – HMRC guidance on tax

Determining the tax position of an individual where clawback provisions have been operated by the employer can be complex. HMRC has now amended the Employment Income Manual to provide guidance on its interpretation of the current position.

The guidance makes it clear that in order for any repayment to an employer to be treated as "negative general earnings" by the individual (and hence be capable of being set-off against positive earnings in that tax year) it must relate directly to the employment and derive from the employment relationship. For example, the repayment of a cash bonus would derive from the employment contract whereas the payment of an amount by an employee to the employer under a contractual claim for breach of a restrictive covenant would not. The Employment Income Manual sets out a number of helpful examples of how negative general earnings will work in practice where cash bonuses are clawed back.

Relief for negative taxable earnings should be claimed through self-assessment – although we are aware that in some circumstances HMRC has allowed the negative taxable earning rebate to be run through payroll so it is worth checking with HMRC on a case by case basis. There is no corresponding negative earnings provision in respect of national insurance contributions and currently no way to reclaim NICs original paid on an amount subsequently clawed back – although again, we are aware of situations where HMRC has allowed NICs to be reclaimed through payroll so it is always worth an approach HMRC.

The tax treatment where shares are forfeited is, unfortunately, less generous. The tax treatment outlined above only applies to amounts which were originally taxed as "general earnings", whereas tax charged in respect of shares is usually taxed as "specific employment income". There is no concept of "negative specific employment income" in the tax legislation and therefore no relief is currently available in these circumstances. The tax position where an individual is required to repay a cash amount equal to the value of shares received (rather than forfeit the actual shares) remains unclear.

Corporate Governance

High Pay Centre's "Fat Cat Wednesday" campaign

The spotlight remained firmly focused on executive pay at the start of 2017 with the High Pay Centre's (HPC) claim that by lunchtime on Wednesday 4 January 2017, CEOs of FTSE 100 companies would, on average, have earned the equivalent of the amount a typical UK worker will earn during the whole of 2017.

As part of its campaign to make the publication of pay ratios compulsory, the HPC calculates that the average pay ratio between FTSE 100 CEOs and an average employee is 129 to 1. The HPC highlights that this equates to an average hourly rate of pay for CEOs of over £1,000 an hour compared to the national living wage of £7.20 per hour.

It is worth noting that the compulsory publication of pay ratios is supported by the Investment Association and is one of the key proposals set out in the Government's current Green Paper on Corporate Governance Reform.

The HPC states that it is "an independent non-party think tank established to monitor pay at the top of the income distribution and set out a road map towards better business and economic success".

Financial Reporting Council publishes it report on the implementation of the UK Corporate Governance and Stewardship Codes during 2016

The Financial Reporting Council (FRC) has published a report which:

  • gives an assessment of corporate governance and stewardship in the UK in 2016;
  • reports on the quality of compliance with, and reporting against, the UK Corporate Governance Code (Governance Code) and UK Stewardship Code (Stewardship Code);
  • gives the FRC's findings on the quality of engagement between companies and shareholders; and
  • indicates where the FRC would like to see changes in corporate governance behaviour or reporting.

The report summarises and comments on other relevant changes during 2016, including the implications of the focus on corporate governance by the Government and the BEIS Select Committee. Highlights from the report in relation to remuneration include:

  • compliance with the Governance Code remains high. 90% of FTSE 350 companies report compliance with all, or all but one or two, of the Code's 54 provisions. Full compliance has risen from 57% to 62%;
  • there was generally reduced investor support for remuneration resolutions, with concern noted in relation to a lack of transparency about the link between executive pay and performance. That said, the vast majority of the FTSE 350 have taken forward the recommendations of the 2014 iteration of the Governance Code: 91% now have some form of malus and/or clawback provisions on annual bonuses and 78% on LTIPs; and
  • in respect of the comply and explain principle generally, too many explanations were of poor quality. The FRC considers it important that a company explains how an alternative approach is consistent with the relevant Code provision and whether it is time limited.

As a consequence of the BEIS Select Committee Inquiry and BEIS Green Paper on corporate governance, the FRC expects to consult on changes to the Governance Code in 2017.

Pensions and Lifetime Savings Association publishes it new Corporate Governance Policy and Voting Guidelines 2017

The Pensions and Lifetime Savings Association (PLSA) has updated its Corporate Governance Policy and Voting Guidelines. Its key change in respect of remuneration is the recommendation that if shareholders vote against a company’s remuneration policy, they should also oppose the re-election of the remuneration committee chair as a company director.

The PLSA recently published research revealing that 85% of pension funds were concerned by the pay gap between executives and ordinary workers. The research also showed that while there were significant votes against pay practices at a number of FTSE 350 companies, there was little opposition to the re-election of the remuneration committee chairs. The new Guidelines are designed to ensure that "the individuals responsible for a company’s executive pay practices are held to account".

The PLSA believes that there is only questionable evidence that pay incentives are necessary to motivate or reward executives and to achieve success for companies. It urges remuneration committees to take a critical and challenging approach to pay increases and to be prepared to exert downward pressure on executive pay. As in previous years, the Guidelines set out the circumstances that are likely to result in a vote against the remuneration report and/or remuneration policy.

The world's largest asset manager, Blackrock, urges companies to rein in executive pay in letter to FTSE 350 boards

Blackrock has updated its "Approach to Executive Remuneration in Europe, the Middle East and Africa" and at the same time written to the boards of the FTSE 350 making it clear that it will only vote in favour of the resolution to approve the remuneration report where pay increases for directors were reflected in increases to workers' wages. Blackrock also focused on termination payments for executive directors, again making it clear that it would not support severance packages for executive directors whose employment is terminated for poor performance, who chose to leave the company or who retire.

Share Dealing by PDMRs

The European Securities and Markets Authority updates its Q&As on MAR

The European Securities and Markets Authority (ESMA) has updated its Q&As on the Market Abuse Regulation (MAR) to make it clear that:

  • the value of options needs to be taken into account when calculating the cumulated amount of the transactions of a PDMR (or a person closely associated with a PDMR), in order to determine whether the EUR5,000 threshold has been crossed (which would trigger the duty to notify and disclose all subsequent transactions); and
  • for the purpose of the EUR 5,000 threshold calculation, the value of the options should be based on "the economic value assigned to the options by the issuer when granting them". If the economic value is not known, the price to consider should be based on an option pricing model that is generally accepted in the reasonable opinion of the PDMR. This model determines the price of the granted option based on variables such as the current share price of the issuer, exercise price of the option and time until expiry of the option.

It is worth noting however that:

  • most UK listed companies have chosen to ignore the EUR 5000 threshold and instead disclose all transactions in respect of PDMR and their closely associated persons; and
  • the above calculation is only relevant for the purpose of determining the disclosure threshold. It does not impact on the notification to the market, where the price field for options granted for free to managers or employees should be to be populated with "0" (zero).