29 January 2021

China’s State Administration of Foreign Exchange, Shanghai Branch (Shanghai SAFE), has verbally notified our local partner firm, Martin Hu & Partners, that the annual re-registration requirements for equity plans registered with Shanghai SAFE is no longer required.

Background
 
Companies listed outside of China that wish to offer equity plans in China must register the plan with a local branch of China’s State Administration of Foreign Exchange, known as “SAFE”. Once the registration process is complete, companies can offer share awards to their local employees.
 
A range of ongoing requirements apply following the registration. The Shanghai SAFE, for example, has historically required quarterly filings, a filing for any significant change to the existing registration, and an annual re-registration process.
 
What has changed?
 
The annual re-registration process for equity plans registered with Shanghai SAFE is no longer required.
 
Shanghai SAFE will continue to require a filing if there is any significant change to the existing registration. As a reminder, any application for a significant change must be made to SAFE or through the designated bank within 3 months after the change.
 
A ‘significant change’ for these purposes includes (but is not limited to): 

1. one or more new plans being added to the SAFE registration, or a currently registered plan being removed from the registration;
2. significant changes to the offshore listed company, such as a merger or restructuring, and as a result, the information of the listed company and/or the number of the onshore entities are changed;
3. a change to the offshore trustee;
4. a change to the onshore agency;
5. any significant change to the plan implementation related to the cash contribution or transfer, etc.; and
6. other significant changes subject to the discretion of Shanghai SAFE. 

Any changes to the SAFE registration (including the regular participants’ list update) other than the significant changes, as listed above, are not required to be reported to SAFE regularly but can be registered together with the registration of a significant change.
 
Our local partner firm also notes that, from 2022, a company may apply for the outbound remittance foreign exchange quota (if it is not a “nil quota”) on a three-year basis. If a quota for any single year is exceeded, that must continue to be updated each year.
 
We are not aware of any change in process for equity plans registered with a SAFE branch in any other part of China, nor are we aware of any change in the requirements to make quarterly filings with Shanghai SAFE.
 
When did / will the changes takes effect?
 
There is no clear effective date for the new policy.
 
It is likely that any annual re-registration submissions that have already been submitted, but for which SAFE consent has not yet been approved, will be dealt with on a case by case basis.
 
Our local partner firm note that they have so far only heard back from Shanghai SAFE on one outstanding application for annual re-registration and, in that case, the SAFE official requested that the application be withdrawn, in line with the new policy.
 
Tapestry comment 
This will be a welcomed development for companies offering equity plans in China under a SAFE registration issued by Shanghai SAFE. The removal of the annual re-registration process and the proposed changes to the quota requirements will remove or minimise an administrative burden for affected companies.
 
We are seeing an increasing number of global companies offer share awards to employees resident in China, with a significant number of those making a registration with Shanghai SAFE.
 
The ongoing reporting obligations for SAFE registrations are burdensome and can be complicated, especially if you have a large number of participants and/or need to report on the effect of any local acquisitions or disposals of entities. Whichever province your registration is made in, make sure that you are up to speed with the obligations that apply to you and start your preparations for each filing well in advance.
 
We would like to thank our partner firm in China, Martin Hu & Partners, for alerting us to this change.
 
If you have any questions on this alert, please do let us know.

Matthew Hunter and Sonia Taylor

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19 January 2021

The Investment Association (IA) has published its shareholder priorities for UK listed companies in 2021. These are areas that the IA has identified as critical in driving long-term value for companies.

This year, the report focuses on the same priority areas as in 2020: climate change, audit quality, stakeholder engagement and diversity. The IA notes that these issues have remained important throughout 2020 and the COVID-19 pandemic.

The report provides an overview of the progress made against the IA’s expectations on these issues set out in the 2020 report, as well as its updated expectations for 2021. It also sets out the approach that the IA’s corporate governance research service (IVIS) will take to assessing companies with year ends on or after 31 December 2020 on these issues, including its approach to giving amber or red top recommendations in certain cases.

The full 2021 report can be accessed here. Tapestry’s summary of the 2020 report can be accessed here.

The key points from the 2021 report are set out below.

1.  Responding to climate change

In its 2020 shareholder priorities report, the IA called on UK listed companies to increase the climate-related disclosures they include in their annual reports, by reporting in line with the Task Force on Climate-related Financial Disclosures (TCFD). The TCFD disclosures cover four pillars: governance of climate-related risks and opportunities, assessment and management of climate-related risk, how the company’s strategy takes into account the impact of climate change, and setting climate change-related metrics and targets.

The IA notes that progress is promising in this area, with the number of FTSE 100 companies reporting against at least some of the TCFD pillars in 2020 more than doubling from the previous year (up to 77 in 2020) and 53% of those companies reporting against all four TCFD pillars.

For 2021, investors expect all listed companies to be reporting against all four TCFD pillars and want those disclosures to be more meaningful. To assist with this, the IA recommends companies use the Sustainability Accounting Standards Board’s (SASB) sector specific guidance to determine what information investors will find useful. Investors also expect companies to clearly identify those responsible for the oversight and management of the company’s response to climate change, as well as communicating their path to achieving net zero emissions by 2050 (at the latest).

To support these disclosures IVIS will, for the first time, amber top any company in a high risk sector that is not disclosing against all four TCFD pillars. High risk sectors are identified in the 2021 report and include financial services, energy companies and the food sector.

IVIS will ask companies appropriate questions to identify whether they are making the above disclosures, including the impact of climate-related risk on their approach to capital management.

IVIS also expects companies to include a statement in their annual report that the directors have considered material climate-related matters when preparing and signing-off the company’s accounts.

2.  Audit quality

The IA is disappointed with companies’ progress against the expectations for improved audit quality in the 2020 report. Despite calls from the IA for audit committees to disclose how they ensured that their auditors had delivered a high-quality audit, including by challenging management’s judgements and assumptions, the IA found that 94% of FTSE 100 companies failed to provide evidence of how they assessed the quality of the audit, and only 22% of FTSE 100 companies demonstrated how the audit committee had challenged management’s judgement.

The IA will continue to monitor audit quality disclosures and has noted that if it does not see progress in 2021 it will introduce a colour top approach in 2022.

3.  Stakeholder engagement

In 2020, the IA reviewed how companies were responding to the new provisions in the UK Corporate Governance Code, and certain director reporting requirements, that require boards to identify and engage with their material stakeholders.

The IA found that disclosures in this area were generally good, however, the IA identified that improvements could be made by including more detail around how the board responded to the views of its stakeholders and how those views impacted decisions and outcomes.

For 2021, the IA wants meaningful disclosures in relation to how the company has continued to engage with stakeholders through the pandemic and how the board has taken those views into account in making decisions. 

4.  Diversity

Continued improvement in terms of diversity at board level, in senior leadership and throughout the workforce was another important issue for the IA in 2020. Whilst improvements have continued to be made in terms of gender diversity (only one all-male board remains in the FTSE 350), the IA notes that there was little progress in improving ethnic diversity in 2020. 37% of FTSE 100 companies still do not have any directors from an ethnic minority on their boards and the IA sees lack of disclosure in this area as a real barrier to change (only 27% of FTSE 100 companies disclosed the board’s ethnic diversity in 2020).

To support change in this area (maintaining progress towards the gender diversity targets in the Hampton-Alexander Review and the ethnic diversity targets in the Parker Review), the IA will continue to colour top the corporate governance reports of companies falling short of investors' expectations:

Gender diversity:

• Companies with 30% or less women on boards – red top (FTSE 350), amber top (FTSE SmallCap)
• Companies with 25% or less women in senior management – red top (FTSE 350), amber top (FTSE SmallCap)

Ethnic diversity:

• FTSE 350 companies who do not disclose either the ethnic diversity of the board, or the action plan towards meeting the Parker Review targets – amber top

Tapestry comment
The IA has identified each of these four areas as critical in driving long term value creation for companies. Good governance, including effectively managing the risks in these areas, will help ensure companies can continue to deliver the best results for their stakeholders.

It is interesting to see where progress has been made against the priorities and expectations set out in the 2020 report, which has clearly driven some of the updated expectations for this year. Diversity and climate change clearly continue to be particularly key areas, with the move to colour topping more companies that are not meeting expectations. Companies will need to consider the new disclosure requirements when preparing this year's annual reports.

The IA’s priorities for 2021 align with calls we’re seeing for increased disclosure from other large and institutional investors. For example, in its recently updated guidance, Glass Lewis has requested meaningful disclosures against the ethnic diversity targets in the Parker Review and will consider voting against the nomination chair in future if disclosures are not adequate or if improvements are not sufficient.

They also align with recent changes to the UK Listing Rules, requiring all UK Premium listed companies to make disclosures in line with the TCFD pillars for accounting periods from 1 January 2021 onwards, or else explain why not.

We recently held a webinar covering Q4 2020 updates to remuneration-related guidance from key institutional investors, looking at their approach to performance conditions (in-flight adjustments and for new awards), ESG metrics, 2020 bonuses, 2021 LTIP awards, post-employment shareholding requirements and new disclosure requirements, amongst other matters. If you would like a copy of the recording of the webinar, please let us know.

If you have any questions surrounding the IA’s shareholder expectations, or would like to discuss any of the updated disclosures required in your Directors’ Remuneration Report this year, then please do get in touch.

Hannah Needle

14 January 2021

Most plans contain “good leaver” and “bad leaver” provisions. Globally, good leavers are generally allowed to keep their awards, whereas bad leavers lose their awards.

For many years it has been well known that German labour law is very employee friendly. There has always been a risk that companies could not rely on their bad leaver termination provisions in Germany. However, a recent case means that bad leaver termination provisions are now more likely to be enforceable. The case was decided by the Berlin-Brandenburg Regional Labour Court.

Key facts

The key facts were:

• The incentive plan had been approved by the local German works council.
• The incentive plan had a cut-off date – so that if an individual left before that date they lost their awards. This was a classic bad leaver provision.
• The individual terminated their employment before the cut-off date set out in the plan rules.
• The Court upheld the bad leaver provision.

Reasoning

In the Court's view, the cut-off date clause was legally valid and enforceable for two reasons:

• Because it was not only related to the plaintiff's performance - but also to their loyalty. The plan was designed to increase retention. The Court made clear that if the payment had depended solely on performance they would not have upheld the provision; and
• The plan had been approved by the works council. A previous decision in 2013 went the other way – but in that case the contract was an individual contract and was not agreed by the works council.

Tapestry Comment
This case is good news. It does not mean that bad leaver provisions will now always be enforced in Germany - but it does mean that those provisions are more likely to be enforced if:

• The award is clearly to record loyalty as well as performance; and
• If the plan is approved by the works council.

We understand that works council approval can be time consuming to obtain. However, if you have a significant German employee population, it may be worth the effort of getting works council approval to improve enforceability.
 
If you would like to discuss this update, or anything else, please do contact us. 

Sally Blanchflower and Sharon Thwaites

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8 January 2021

Happy New Year and we hope that you had a relaxing break over the Holidays.

Staying ahead of the curve on regulatory and tax compliance is a never-ending task for companies. 

To help you keep on top of recent developments, here is our first quarterly Worldwide Wrap-Up of 2021, with some of the most recent changes that should be on your radar. We have summarised these topics briefly in this alert, however they will be covered in more detail along with other recent developments on our 13 January webinar.

Brexit - data protection
The UK-EU Trade and Co-operation Agreement (TCA), signed on Christmas Eve, included some good news on the transfer of data from the EU to the UK. The TCA includes a 4 month (extendable to 6 month) transition period for data protection rules. During this period the UK will not be treated as a third country under GDPR. This means that data flows to the UK that are in compliance with GDPR can continue unchanged as long as the UK makes no major changes to its data processing laws. The new transition period allows further time for the EU Commission to adopt an adequacy decision, confirming that the UK’s data protection rules will be treated with equivalent status to the GDPR.
Tapestry comment
Although this update is not incentive plan specific, there are data compliance implications when operating global plans. This arrangement increases the likelihood that the UK will receive an adequacy decision or, at the very least, it gives companies operating in the UK additional breathing space to put in place or update systems (including documentation and privacy notices), to reflect the UK’s status as a third country for GDPR in the event that an adequacy decision is not adopted.

Canada - cap on tax deduction
We reported in our recent alert (here), that the Canadian government is moving ahead with plans to impose an annual cap on the value of employee stock options that can qualify for preferential tax treatment. Currently, employees receiving stock options can benefit from a 50% deduction on the income tax payable. Under the proposed new rules, under certain circumstances, only options up to CAD200,000 in each year will be eligible for the tax deduction. If approved, the changes will apply to options granted from 1 July 2021.
Tapestry comment
This proposal has been under discussion for some time, and it seems increasingly likely that it will finally come into force this year. Companies offering share options to employees in Canada will need to keep an eye on how this develops, and may consider how to take advantage of the extension of the start date (now 1 July 2021) to review existing plans and maybe bring forward grants, or even put in place a new plan to ensure that employees can benefit from the current rules.

Gig economy workers
Several recent reports have looked at whether workers in the global gig economy are treated as employees or as self-employed contractors. In recent cases in Australia and Italy, workers have claimed more extensive rights (e.g. minimum wages and sick pay). In California, voters passed Proposition 22 which will exempt app-based transport and delivery companies from the obligation to provide employee benefits to workers by classifying drivers as independent contractors.
Tapestry comment
The growth in the gig economy, with increasing numbers of people working as self-employed or contract workers, has created a model where flexibility for some is seen as insecurity and loss of benefits for others. The classification of workers is important from an incentive plans perspective, as non-employees are generally excluded from the benefits of such plans. Incentive plans will usually be limited to employees, and both tax and regulatory rules which provide tax breaks or securities exemptions for employee share plans may not extend to non-employees, including contractors. Keep these global classifications under review if your workforce falls into this category.

Global tax rates
For many countries, revised tax rates start on New Year’s Day. Often the rates are only announced in the last days of December, and in some cases the final figures are not available until well into January, sometimes later. Our international advisors provide us with new rates to update OnTap as quickly as they become available. Current changes include:  
Argentina - "millionaire's tax" charge for individuals with worldwide assets over approx. USD2.5 million.
Austria - Basic rates reduced to 20% but reduction in top rate postponed.
Croatia - Personal tax rates reduced for both income and capital.
Kenya - Top 30% rate reinstated.
Malaysia - Social security (EPF contribution) for employees is reduced from 11% to 9%.
Netherlands - Basic rates income tax reduced but tax on capital increased.
Poland - Plan to abolish cap on social security contributions postponed.
Tapestry comment
The above list is not exhaustive and we will discuss the detail of these changes in our 13 January webinar. Many countries have made adjustments to tax bands and to social security caps. If you need specific advice for any jurisdiction, please let us know.

Latvia - changes to taxation of employee share plans
Rules introduced in 2013 allowed the deferral of tax on employee share income to the sale of the shares. Under the 2013 rules, the shares were subject to a 3 year holding period during which the participants had to remain in the employment of the issuer or its subsidiary. From 12 January 2021, the holding period will be reduced to 12 months and participants will be able to benefit from the tax treatment even if their employment is terminated in certain circumstances.
Tapestry comment
This is a significant change to the tax treatment of employee share plans. The reduction in the holding period from 36 to 12 months allows greater flexibility in the operation of share plans. For employees, the ability to continue to benefit from the plan, even if they chose to switch jobs, underlines the value of share plan participation.

UK - off-payroll working in the private sector
The UK was due to extend off-payroll working rules to include the private sector from April 2020. Due to the impact of the Covid pandemic, this was postponed until April this year. Since 2017, public sector employers have been responsible for determining whether a worker should be deemed to be an employee, and operating payroll and accounting for income tax and NICs for such workers where the off-payroll working rules apply. In the private sector this burden still falls on an intermediary, which is usually a worker’s limited company. The extension of these off-payroll working rules to the private sector will mean that medium and large company end-user clients in the private sector are also caught by the rules. An attempt to postpone the extension of the rules for an additional two years was rejected in July and it seems likely that the new rules will apply from 6 April 2021.
Tapestry comment
This is an important topic that all employers should be mindful of. The majority of companies will need to be aware of their responsibility to determine the employment status of a worker for tax purposes and how to actually do this. Companies should ensure that tax teams still have this on their radar and take the appropriate measures to prepare for these changes by ensuring workers are informed about off-payroll working determinations and establishing a process for dealing with any worker disputes. Where the contract or work practices change in any way, it is important for companies to review the IR35 rules to check whether they should apply.

USA - $1 million penalty for FBAR non-reporting
As covered in our December alert (here), a former CEO of a US pharmaceutical company was slapped with a USD1 million penalty for failing to report a foreign bank account under the US Bank Secrecy Act. Under the reporting requirements, individuals must report certain foreign financial accounts by filing a Report of Foreign Bank and Financial Accounts (better known as FBAR) by 15 April each year. The penalty for non-compliance is a fine equivalent to 50% of the amount not reported.
Tapestry comment
This case serves as a reminder for companies and individuals to stay on top of their foreign asset reporting obligations, which may arise as a result of operating international incentive plans. Although particularly strict in the US, similar obligations can arise in other jurisdictions and when operating incentive plans globally, so it is important to be aware of any reporting obligations for local employing entities and participants, which maybe unfamiliar to them.

USA - New York modernises Blue Sky filing for Reg D Offerings
New York has recently modernised the blue sky (state) filing requirements for securities sold or offered in New York using the exemptions available under Regulation D of the Securities Act. The new amendments update the notice filing process for issuers conducting private placements, notably by eliminating the need to file a Form 99 annually, and instead requiring issuers to electronically file a notice through the NASSA Electronic Filing Depository (EFD).
Tapestry comment
This is good news - the Form 99 filing was cumbersome and the new filing will streamline the compliance process. For companies relying on Reg D that have made annual filings in New York, please let us know if you would like more information on this change. Thank you to our US counsel, Harter Secrest & Emery LLP, for drawing this update to our attention.

USA - Reminder for Annual ISO and ESPP Reporting
The annual deadlines are fast approaching for delivering participant information statements (to current and former employees), and filing IRS information returns to report exercises of incentive stock options (ISOs) and transfers of certain shares of stock obtained by participants under employee stock purchase plans (ESPPs). Compliance with the participant information statement requirement is made by providing certain forms to relevant participants by 1 February 2021. The same forms are also used for IRS information returns, which must be filed with the IRS by 1 March 2021 (for paper filings) or 31 March 2021 (for electronic filings).
Tapestry comment
Tax reporting is an essential part of compliance and the US is a very high risk and, for most of our clients, important jurisdiction.  Please let us know if we can help you with these filings.

if you have any questions, or would like to discuss any element of legal and tax compliance for your global incentive plans, do get in touch - we would be delighted to help!

Sarah Bruce, Lorna Parkin and Sonia Taylor

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22 December 2020

Earlier this month Arthur Bedrosian, the former CEO of a US pharmaceutical company, was found liable for a $1 million penalty for having failed to report a foreign bank account.

This case serves as a reminder for companies and individuals to stay on top of their foreign asset reporting obligations, which may arise as a result of operating international incentive plans.

Foreign asset reporting in the US - a reminder

In the US, there are various foreign asset reporting requirements, including under the Bank Secrecy Act. Under those requirements, individuals must report certain foreign financial accounts by filing a Report of Foreign Bank and Financial Accounts (FBAR).

This filing applies to all US persons who have an interest in (or signature authority over) one or more covered non-US financial accounts (certain "non-covered" accounts are exempt), whose aggregate value exceeds USD10,000 at any time during a calendar year.

The FBAR is an annual report, which should be filed by the 15 April following the calendar year being reported.

Summary of the case

In this case, Bedrosian was found to have acted carelessly in failing to review his signed tax forms. These forms failed to disclose a Swiss bank account containing approximately $1.9 million.

The US courts had previously concluded in 2017 that Bedrosian’s conduct was not ‘wilful’. Now the case has reached the federal court and in their view: Bedrosian knew about the FBAR reporting requirement, was taking measures to avoid the account’s detection, had a significant amount in his account, and ultimately signed his tax forms despite claiming not to review them.

On this basis, Bedrosian was found to have acted deliberately, and in doing so was liable for a severe fine of 50% of the amount in the account.

Tapestry comment
This case is a clear reminder of the potentially severe consequences that can arise when foreign asset reporting requirements are not complied with.

With the headline grabbing fine being 50% of the amount not reported, companies and individuals should ensure they keep on top of the FBAR reporting requirements.

It is also worth noting that whilst these requirements are particularly strict in the US, such requirements do not only exist there. Similar obligations arise all around the world and when operating incentive plans globally, it is important to be aware of the obligations that could be being created for local employing entities and participants, which maybe unfamiliar to them. Whilst some companies see this as the individuals’ responsibility, many others choose to share such information with their participants if they want to be particularly helpful in this area.

For our OnTap subscribers, the foreign asset reporting requirements are found in the Legal Report for each country.

If you would like to discuss this update, or any other foreign asset reporting requirements, please do contact us. 

We would like to thank Harter, Secrest & Emery LLP for bringing this case to our attention.

Sally Blanchflower and Tom Parker

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16 December 2020

The Canadian government is finally moving forward with plans to impose an annual cap on the value of employee stock options that can qualify for preferential tax treatment.

This development has been on the radar since it was announced in the 2019 federal budget, with an anticipated start date of 1 January 2020 (see here). The introduction of the change was initially delayed while the proposals were subject to consultation and then further delayed when Covid-19 caused the Canadian government to postpone the 2020 federal budget. The government included revised proposals for the tax treatment of stock options in the Fall Economic Statement (released on 30 November), which are now due to come into force on 1 July 2021.

How does the preferential tax treatment for stock options currently work?

When an employee exercises an option granted under an employee share plan, income tax is due on the positive difference between the value of the shares on acquisition and the exercise price paid by the employee. Under the current rules, if certain conditions are met, as long as the exercise price is not less than the fair market value of the shares at the time that the options were granted, the employee can benefit from a 50% deduction on the income tax payable. The beneficial tax treatment does not apply to other types of share plan and separate rules apply in Quebec.

What is going to change?

The proposed change is to limit the scope of the benefit by introducing an annual cap on the value of options that will be eligible for the tax deduction (at the moment there is no cap). Under the proposal, an employee will only be able to claim a deduction in each calendar year for stock options valued up to CAD200,000 that become exercisable during that year. The valuation is based on the fair market value of the underlying shares at the grant date. If the annual limit is exceeded during a calendar year, the preferential tax treatment will apply to the first options granted.

Which employees are covered by the cap? 

Initially, the government announced that the cap would apply to options granted to employees working for ‘large, long-established, mature firms’, the aim being to exclude small companies and start-ups, but there was no clear explanation as to how this would be defined. Under the new proposal, the cap will not apply to employee stock options granted by Canadian-controlled private corporations (CCPCs), or by non-CCPCs whose gross revenues, or whose corporate group gross revenues, are CAD500 million or less.

How does this affect the employer?

Currently, employers are not able to claim a corporate tax deduction where shares are issued following the exercise of an employee stock option. Under the proposal, employers may be able to claim a deduction for non-qualifying stock options, that is options which do not qualify for the 50% tax deduction. In addition, under the new proposals, the employer will be able to designate at grant that certain of the stock options will be treated as non-qualifying, and the non-qualifying securities will not be eligible for the preferential tax treatment but will be eligible for a corporate tax deduction. The employer must notify the employees and the Canadian tax authority within thirty days of grant if any of the stock options will be non-qualifying.

Is there any other employer reporting?

The employer will be required to report to the tax authority the issue of stock options for non-qualified securities. The report will be submitted on a prescribed form (yet to be released). Employers will also be required to track which options are qualified for the purposes of income tax withholding and for completing form T4 (the summary of the remuneration paid to an employee).

What is the timing?

 The proposals are not yet in force and require approval from the Canadian parliament. Assuming the changes are approved, they will apply to options granted from 1 July 2021. The existing beneficial tax treatment will apply to all awards for options granted before 1 July 2021.

Summary

The key take away points from the new proposals are:

• The beneficial tax treatment for stock options will be capped at CAD200,000 per calendar year of vesting.
• The cap is based on the share price at time of grant.
• Employers can designate that certain options will be non-qualifying (i.e. where the employee pays the full amount of tax).
• Employers can receive a corporate tax deduction for non-qualifying options
• Employers will have additional reporting obligations.
• The rules will not apply to employees of CCPCs or companies with revenue below CAD500 million.
• The proposals are due to apply to options granted from 1 July 2021.

Tapestry comment
The availability of the 50% tax deduction has made options popular in Canada, and the new tax treatment may result in a switch to other types of incentive plans. Employees who are granted options from 1 July 2021 can however still take advantage of the beneficial tax treatment up to the CAD200,000 cap.

The extension of the starting date to 1 July 2021 allows companies additional time to review existing plans and to potentially bring forward grants, or even put in place new plans to ensure that grants are made before the cut-off date, so that employees can benefit from the current rules.

The availability of a corporate tax deduction for employers for the non-qualifying options is a positive development, although employers will need to weigh up the competing advantages of allowing employees to take advantage of the beneficial tax treatment against the ability of the employer to take a tax deduction.

We will keep you informed of the progress of this development.

If you would like to discuss this update, or anything else, please do contact us. 

Sharon Thwaites and Sonia Taylor

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13 November 2020

The Institutional Shareholder Services (ISS) has published its updated proxy voting guidelines for the UK and Ireland. These guidelines apply for shareholder meetings on or after 1 February 2021. The guidelines can be accessed here.

The key changes for “incentives” in the guidelines concern: 

• remuneration policy provisions covering pensions and post-employment shareholding;
• gender diversity;
• “overboarding”; and
• the exceptional grounds for votes against individual directors.

Remuneration policy votes
 
The guidelines have been updated following the publication of the 2018 UK Corporate Governance Code (the Code). Shareholders are still expected to decide how to vote on a case-by-case basis. They are now also asked to consider:

• the extent to which pension contributions are aligned with those available to the wider workforce, as recommended by the Code; and
• whether an appropriate post-employment shareholding requirement is in place.

The guidelines set out a number of other considerations for shareholders, which are unchanged. These include checking if the overall remuneration policy, specific scheme structures and components and caps (as well as items like malus and clawback) are straightforward, clear and appropriate and in-line with market practice, ensuring performance conditions are clearly aligned with the company's strategic objectives, limiting notice periods to 12 months, and ensuring non-executives do not receive performance related remuneration.

Gender diversity
ISS have made a number of adjustments to the guidelines to secure greater levels of gender diversity. Following the recommendations of the Hampton-Alexander Review of FTSE 350 companies to improve the representation of women on their boards, ISS proposes that:

• larger (FTSE350) companies in the UK and Ireland have a board comprised of at least 33 percent women; and
• smaller companies (e.g. FTSE SmallCap and larger AIM listed companies) have at least one woman on the board.

ISS will generally recommend against the chair of the nomination committee (or other directors on a case-by-case basis) if these guidelines are not followed.

Mitigating factors include compliance with the relevant board diversity standard at the company’s preceding AGM and a public commitment to comply with the relevant standard within a year.

Overboarding

ISS’ default stance remains unchanged:  they may recommend a vote against directors who hold an excessive number of board roles. This would be applied strictly for directors on boards of complex companies, those in highly regulated sectors, or directors who chair a number of key committees.

ISS has expanded this guidance to provide that a more lenient approach is acceptable “for directors who serve on the boards of less complex companies (for example, externally managed investment companies)".

Votes against directors

In certain extraordinary circumstances, ISS will recommend a vote against an individual director. The guidelines previously stated that these circumstances would include:

• material failures of governance, stewardship, or risk oversight; or
• egregious actions related to the director's service on other boards that raise substantial doubt about that individual's ability to effectively oversee management and to serve the best interests of shareholders at any company.

These guidelines remain. ISS has expanded the first item to include "demonstrably poor risk oversight of environmental and social issues, including climate change".

Tapestry comment
The changes concerning remuneration policies are expected. The pension and post-employment holding period rules were two of the more challenging innovations found in the Code and many companies have approached implementation by waiting to see market sentiment. Whilst not as prescriptive as other voting guidance (such as that issued by the Investment Association) the recommendations on remuneration are a reminder that “waiting and watching” the market is probably not going to be acceptable to shareholders. The ISS is expecting demonstrable action here.

Likewise, the moves to drive greater levels of women membership of boards provide another indicator in the inexorable direction of travel to a more representative and balanced executive population in listed companies. It is clear that companies need to be taking steps to address gender imbalance on boards – and soon, given that shareholders have been given another hammer to help bring down the glass ceiling.

One notable absence from the guidelines is any update on the ISS’ approach to COVID-19 in the context of executive remuneration. Whilst the ISS did issue some guidance on their approach to COVID-19 in this context back in April 2020 (see here), the ISS has not taken this opportunity to update its approach. Instead, it has said that it will ‘carry this or similar policy guidance into 2021 and update going forward as needed’. An update on the ISS’ approach would have been valued by many December year-end companies, given many will soon be at the point where decisions have to be made on executive remuneration for 2021.

Finally, we agree with the moves to expand the grounds to vote against directors to reflect bad management of environmental and social issues. These are undeniably of huge importance from a public policy perspective and climate change might be the overriding issue of this generation, as well as several generations to come. Failure to address these issues will have dire consequences for us all – not just shareholders! The move feels like a mild rebuke to certain executives (and politicians) who have been less than optimal in their approach to these hot button topics.

If you have any questions about this alert, please do let us know.

Chris Fallon and Emma Parker

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12 November 2020

Potential significant tax changes for share plans operating in UK

The UK Office of Tax Simplification (OTS) has produced the first of its reports into the reform of capital gains tax (CGT). The Government has charged the OTS with finding ways of raising more revenue to help cover the costs it has incurred during the pandemic and the OTS makes recommendations which could lead to increases in CGT rates, loss of several types of CGT relief and also dramatically impact certain types of employee share planning arrangements in the UK. The report is available for download here.

The key news is the OTS wants the Government to look at aligning CGT and Income Tax. This is likely to result in potentially big increases to CGT rates and reductions in CGT reliefs such as the annual exempt amount.

The headline news for incentives is the OTS recommending the Government to: 

1. consider the effectiveness of tax-advantaged plans - the all employee Sharesave and SIP in particular
2. increase the ways in which certain employee share awards are subject to Income Tax; and
3. tax owner manager and employee reward more consistently.

Any of these measures could result in major changes to employee incentives in the UK.

Background

This report – the first of two reviews of CGT - was commissioned by the Chancellor of the Exchequer in July to “identify opportunities relating to administrative and technical issues as well as areas where the present rules can distort behaviour or do not meet their policy intent.” (see our alert: here).   

This report is on the policy design and principles underpinning CGT and the second report will explore key technical and administrative issues and will follow next year.

Findings and Recommendations

The OTS reports a range of areas in which CGT is counter-intuitive, creates odd incentives, or creates opportunities for tax avoidance. In particular, the OTS said that the disparity in CGT and Income Tax rates can distort behaviour and create an incentive for taxpayers to effectively re-characterise income as capital gains. 

The report makes a series of observations and recommendations, the most eye catching of which relate to:

• ensuring greater alignment between CGT and Income Tax,
• reducing, replacing or abolishing reliefs such as the annual exempt amount and Business Asset Disposal relief (the new name for entrepreneurs’ relief); and
• removing the uplift on asset values on death.

From a share plan perspective, the key item and potentially big news is Recommendation 4, which says:

• the Government should consider “… taxing more of the share-based rewards arising from employment, and of the accumulated retained earnings in smaller companies, at Income Tax rates”.

Analysis

First thoughts
Tapestry’s view is that this Recommendation 4 is not perhaps as scary as it sounds. Most employee share awards are already subject to Income Tax in the UK at the time of delivery (like options and conditional awards). We think this recommendation is primarily aimed at:

• growth share plans and similar arrangements; and
• using small close and personal service companies to deliver retained earnings as capital rather than income.

The background to the Recommendation is covered in detail in Chapter 3 of the report. This sets out an explanation of the main forms of share-based awards and how they are taxed. It comments that, unlike share options and other future share rights (like conditional awards) which are largely subject to Income Tax and national insurance contributions (NICs), certain types of upfront share awards can result in employment reward being deferred, accumulated and subject to CGT rather than to Income Tax.

Tax advantaged plans – changes ahead?
The worrying commentary is found in the OTC statements concerning tax advantaged plans.

The report notes that there are public social and economic justifications for supporting the use of tax advantaged all-employee share schemes such as Sharesave and SIP.

Alarmingly, the report appears unconvinced of the merits of these arguments.  It questions whether such plans are the most cost-effective approach to helping people save or encouraging long term share ownership (it states that 38% of Sharesave participants sell their shares immediately after they acquire them instead of focussing on the 62% who keep their shares). It notes that millions of lower paid employees (including those in the public sector, or professional partnerships, or private equity backed companies) cannot access them.  In our view, although there is no explicit recommendation being made, the implication is clear - that the Government should revisit the effectiveness and scope of tax advantaged plans, generally. In the context of the CGT review there is a clear risk the tax reliefs available under plans like SIPs and Sharesave may be removed or reduced. As we note in our comment below – we will seek to counter this view, strongly.

Growth shares under scrutiny
The report particularly focuses on growth share plans. These are plans designed to deliver shares which, broadly, benefit only from increases in the company’s value from the date of award.  They are intended to have little value on acquisition, with little or no Income Tax or NICs to pay at that time.  When the shares are sold, there will be a capital gain based on the difference between the (hopefully high) sale proceeds and (relatively low or nil) amount paid for them.  They attract minimal Income Tax or NICs, with all their growth in value instead being subject to CGT (which is currently at a lower rate of tax). In conclusion, the OTS offer a negative view: “growth shares are similar to share options, as they involve what is likely to be a low tax charge on award with little risk to the employee.” With this report, the likelihood of legislative intervention into such plans has increased considerably. We will watch this space for more detail to see how and the extent to which the Treasury and HMRC make their move and whether similar plans like the jointly owned share plan (which uses a trust arrangement to achieve a similar outcome to growth shares) might be included in such measures.

Personal and closely held companies
The OTS notes that personal service and closely held companies can be used to deliver retained earnings in a tax efficient way. The report states that: “The ability of those conducting their business through Personal Service Companies to roll up retained earnings into what becomes a capital gain produces an additional tax benefit for those with the means and the desire to secure it.”

There have been numerous legislative moves to drive a “fairer” tax status for small personal or closely held companies. The OTS is the latest to add its voice to this issue. It does at least recommend that the scope of any measures in this area should not extend to large publicly listed companies.

Initial conclusions
The OTS notes there are “policy justifications for non-neutrality” in approaching CGT, particularly for tax advantaged all-employee share plans. It notes that any changes to employee share schemes or accumulated retained earnings in close companies would require much more careful consideration and analysis. Nevertheless, the OTS is clear that it regards arrangements like growth share plans as anomalous – they allow shares to be made available to employees on better terms than to other investors, and add to the pressure on the boundary between Income Tax and CGT.

But the report presents evidence that the tax reliefs available under the UK’s suite of tax advantaged share plans is also under scrutiny. There is a real risk that the Government may conclude that certain of the tax reliefs under these plans – the Sharesave and Share Incentive Plan (SIP) in particular – are inefficient, wasteful and do not deliver the stated policy aims for those plans. This is a conclusion which we believe is not supported by  evidence and, as discussed below, needs to be strongly rebutted.

Tapestry comment
The report notes the different aims given to CGT over the years, from ensuring parity between taxing income and gains, to driving risk taking and promoting enterprise. This report leaves the reader in little doubt that the aim of the present administration is more mundane – to deliver efficiency and rationalise the system but above all, increase the tax take. The primary conclusion of Chapter 3 of the Report is that retaining a substantial difference in rates between Income Tax and CGT may put pressure on the boundaries between the two taxes. The implication is that the status quo cannot stand as it leads to distortions and unfairness.

The commentary concerning employee share plans is initially unsurprising. The OTS acknowledges share-based remuneration is a complex area. A key recommendation is to align the tax treatment of income and capital, and the observations concerning employee share plans (particularly using closely held small companies and growth shares) is aligned with this recommendation. 

The focus on growth share planning arrangements is to be expected: they have been on HMRC’s radar for over 10 years and the OTS commentary must surely mean that the CGT-driven outcome of these and similar arrangements is not much longer for this world. Similarly, the comments concerning the disparity in tax between incorporation and employment and how closely-held companies can produce outcomes which distort behaviour, reflect an ongoing and widely heard debate in terms of how best to tax such enterprises fairly without limiting entrepreneurship.

Much more alarming and unheralded are the comments concerning tax advantaged plans - SIPs and SAYE, in particular. The report does acknowledge the policy goals of such plans but the overall tone is clearly one of the unconvinced sceptic. The report acknowledges that a whole swathe of UK employees cannot access these types of plans. In our view that is precisely the problem and the solution should be to broaden and strengthen them, not limit or reduce them! We will be working with our friends at ProShare and other industry representatives to ensure that the Government is convinced of the clear merits and compelling arguments not only to retain these incredibly popular plans but to extend their scope and the extent of their reliefs. The report glosses over the documented positive impact of employee ownership on economic performance and Tapestry’s long held view is that, at a time when harder work and greater productivity is vital, these plans are needed more than ever.

We want to represent the share plans industry and welcome views from our clients. If you would like to get in touch to discuss this, we would be delighted to hear from you to make our collective voice heard.

Sarah Bruce and Chris Fallon

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