Incentive compensation

Typical structures

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

The prevalent types and structures of incentive compensation are as follows.

Short-term incentive programmes

The payment of these bonuses is calculated on the basis of a company’s operational results for a month, quarter, half-year or year. Such arrangements are managed directly by the Russian employer under Russian law.

Long-term incentive programmes (usually lasting for three to five years)Long-term bonus programmes

Employees are granted a bonus payment calculated on the basis of long-term key performance indicators (KPI); the set of KPI depends on management level and position. Such arrangements are managed directly by the Russian employer under Russian law.

Option programmes

Employees are granted call options for a certain number of the company’s shares to be exercised after the expiry of a certain period; when the option is due, employees are entitled either to receive the shares or conclude a share purchase agreement under which shares will then be transferred. Since 1 June 2015, option programmes can be managed directly by the Russian employer under Russian law as options are now set forth by Russian legislation. However, they still have to be tested by courts (in particular, the Supreme Court). Previously, option programmes were either structured using a foreign special purpose vehicle (SPV) or managed through the employer’s foreign parent and governed by foreign (usually English) law. Such structure can still be used but Russian law restrictions applicable to circulation of foreign securities in Russia will need to be considered upon its establishment (see below).

Restricted stock purchase programmes

Employees are granted a certain number of the company’s shares that they cannot transfer or otherwise dispose of. Each employee becomes the absolute owner of the shares after the expiry of a certain period. Apart from the shares, employees receive dividends paid during the term of the programme. Alternatively, the company may redeem the shares from the employee at the end of the programme term. Restricted stock purchase programmes are governed by foreign law and operated through a foreign company as Russian law does not permit contractual limitations of shareholders’ rights other than under shareholders’ or participants’ agreements. Russian law restrictions applicable to circulation of foreign securities in Russia will need to be considered upon establishment of the restricted stock purchase programme and its extension to employees in Russia (see below).

Phantom option or shares programmes

Employees are assigned a certain number of ‘phantom’ shares of the company that give no shareholders’ rights. After the expiry of a certain period employees receive an adjustment between the current value of the company’s shares and the value of the ‘phantom shares’. Being cash-based, phantom programmes may be operated by Russian employers directly under Russian law.

The programmes vary by level or type of organisation. Small or medium-sized companies usually implement short-term incentive programmes that provide monetary awards or a long-term bonus programme, while major companies usually implement long-term incentive programmes based on profits from shareholder capital (comparing with competitors’ results). In addition, the Code of Corporate Governance recommends that all public companies adopt option programmes for their executives and key managing employees.

In non-public companies the operation of real share option plans is exceedingly difficult because of shareholders’ or participants’ pre-emption rights, which means that participants and shareholders have the right to purchase shares that are offered for sale or newly issued by a company before any other persons.

Restricted stock purchase programmes do not work under Russian law. It is prohibited to restrict the disposition of shareholder rights (other than under shareholders’ or participants’ agreements), thus an executive’s ownership rights to shares cannot be contractually limited (eg, by consent of the board to the disposition of shares).

Option programmes structured via a foreign entity are subject to regulatory restrictions. For public placement and circulation in Russia foreign securities and their issuer must satisfy certain requirements and a prospectus must be registered by the Bank of Russia or submitted to a Russian stock exchange. Foreign securities that have not been admitted to public placement or circulation in Russia may only be transferred to a limited number of employees that are ‘qualified investors’. If foreign shares are recognised as securities from a Russian law perspective they may also be transferred via a Russian licensed broker, unless the investment in the foreign entity is structured as an integral part of an employment agreement.

A person is either directly referred to as a qualified investor by the Russian legislation (eg, banks, insurance companies, brokers or the Bank of Russia) or may be classed as a qualified investor if any of the following requirements are met:

  • the individual holds securities or financial instruments of a total value of at least 6 million roubles;
  • the individual has professional experience performing transactions with securities or other financial instruments by virtue of his or her employment with a Russian or foreign organisation as a general rule for at least three years;
  • the individual has performed on the whole at least 10 transactions with securities or other financial instruments per quarter over the past four quarters and at least once in a month, for a total value of at least 6 million roubles;
  • the individual owns certain property of aggregate value not less than 6 million roubles; or
  • the individual has received higher education in economics or has certain certificates (eg, a chartered financial analyst).

There are exceptions to the limitations, for example, if such sale or acquisition is made by:

  • a foreign citizen; or
  • a Russian citizen under his or her employment agreement (including fulfilment of his or her duties thereunder) or in connection with his or her membership of the board of directors or supervisory board of a legal entity.

These restrictions do not apply to phantom programmes.

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?

Generally, the amount or structure of incentive compensation is not subject to maximum limits, with certain exceptions. According to Russian court practice an employer is not limited in the options or structure of incentive compensation and determination of the amount of benefits unless otherwise provided by law.

The Labour Code stipulates certain exceptions for executives of state corporations, state companies, state and municipal enterprises and institutions and entities that are at least 50 per cent owned by the state or municipal bodies. According to article 349.3 of the Labour Code, compensation for termination of an employment contract with the CEO, his or her deputies or the chief financial officer in the event of change of control (or termination of an employment agreement with the CEO without cause), and cumulative remuneration in the event of dismissal of executives for any reason must not exceed the amount of three average monthly salaries. In addition, according to article 145 of the Labour Code, the amount of the average monthly salary of CEOs, their deputies and chief financial officers of state and municipal institutions and enterprises is calculated on the basis of the level of the average monthly salary of other employees of respective organisations. Respective maximum ratios are set forth by legal acts of authorised state bodies. Breach of these ratios will lead to early termination of an officer.

There are also limits on the amount of compensation for executives of Russian credit organisations. At least 40 per cent of the total amount of remuneration must be flexible, and payment of at least 40 per cent of the flexible part must depend on the financial performance of the credit organisation (including deferral or instalment). A combination of monetary and non-monetary forms of compensation may be provided for in the internal regulations of a credit organisation. Monetary forms of the flexible part of the compensation must be linked to changes in share price.

Apart from this, an employer has the right to limit the amount of its incentive compensation at its discretion by its rules and programmes and in collective bargaining or employment agreements.

Compensation stipulated by labour contracts and internal company regulations is treated as employees’ income and is taxed on the same basis and with the same rates applied regardless of the amount of the compensation. Compensation paid to executives in Russia is treated as income received in Russia regardless of the actual place from which the programme is managed. There are no statutory limits on sums of incentive compensation, but in cases where large sums of compensation are paid to executives (who have the right to act on behalf of the company) the risk may arise of such payments being considered as having no reasonable basis.

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 is permissible. There are no limits on the length or type of vesting provisions (or any minimum vesting periods for types of awards). Deferral that restricts the shareholder rights of an employee who is granted shares is, however, illegal (see question 9).

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?

There are no limitations on the individuals or groups eligible to receive the compensation. Arrangements that can only be extended to certain groups of employees may exist in respect of executives of specifically regulated entities (eg, credit institutions as described in question 10).

Recurrent discretionary incentives

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

It cannot be held that recurrent discretionary incentive compensation has become a mandatory contractual entitlement; however, if internal regulations provide that incentive compensation will not be paid in only limited cases, such as violations of work discipline or other particular grounds, and forms a part of salary, an employee who has not received such compensation may file a suit with the court. In this case the employer must provide evidence to the court that there were grounds for refusal to pay compensation.

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?

The type or amount of incentive compensation awarded to an executive potentially affects the compensation that must be awarded to other executives or employees. Article 132 of the Labour Code prohibits any discrimination in remuneration, and the remuneration of an employee must be based on his or her qualifications, complexity of work, and quality and quantity of work, and is not subject to maximum limits. If employees hold the same positions, carry out the same type of work, have the same qualifications and achieve the same work results, the incentive compensation awarded to one employee and not provided to another employee may potentially give rise to claims against their employer.

Mandatory payment

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

It is permissible to require repayment of incentive compensation if such compensation does not form part of an employee’s salary according to his or her employment agreement. If incentive compensation forms part of an employee’s salary, an employer can request its repayment only in cases provided by the law (ie, error in calculations, the employer’s guilt in failure to meet labour standards or time off confirmed by an authorised body, or unlawful actions of an employee that lead to payment of the incentive compensation confirmed by the court). The law does not set forth the circumstances under which repayment of incentive compensation is mandatory.

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

An arrangement may provide that payment is conditioned on continuing employment until the payment date if respective compensation does not form part of an employee’s salary according to his or her employment agreement. The substance of such arrangements depends on the agreement reached between the parties.