Populism, profit-shifting and UK pensions

The demand for corporates and wealthy individuals to adopt greater tax transparency continues to build momentum – the significance of the global reaction to it makes the recent Autumn Statement seem like chicken feed. The reforms being formulated could have a dramatic impact upon tax strategies and corporate governance generally. Whilst it will no doubt present a headache for some C-suite executives, it may make the job of a pension plan trustee easier when assessing the value and strength of the sponsoring employer, particularly where that employer is part of an international group of companies.

Recent developments in this area include:

  • In November 2015 the G20 endorsed an OECD action plan to tackle BEPS (Base Erosion and Profit Shifting) by large multinationals. This is attempting to target an estimated loss to global tax revenues of US$100 to 240 billion annually. In addition to the G20, it has involved a group of 80 developing countries.
  • On 12 April the European Commission proposed a directive obliging large multinationals to publicly disclose their tax and earnings in the European Union.  Separately EU member states have also agreed on a directive to automatically exchange amongst authorities tax-related information on the activities of multinational companies.
  • Since 30 June UK non-listed corporate entities are required to file with Companies House a record of their “Persons with Significant Control”.
  • On 24 November, more than 100 jurisdictions concluded negotiations on a multilateral instrument that will implement a series of tax treaty measures to update international tax rules and lessen the opportunity for tax avoidance by multinational enterprises. The signing ceremony will be in June 2017.

The combined effect of these developments and other is that top executives in large companies will be under increased pressure to ensure that the tax strategies employed in relation to their corporate and personal wealth are fair and reasonable. Even if no change of approach is necessary, they may need to comply with additional red tape.

Whilst this may present a challenge to corporates, the resultant increase in financial transparency may make the job of a pension plan trustee a little easier. A key role of a defined benefit occupational pension plan trustee is to understand the ability and willingness of the sponsoring employer to make good any funding deficit. It is often hard to identify the value of the so-called “employer covenant”, particularly where the sponsoring employer is part of a wider group of companies some of which have no direct obligation to the UK pension plan.

Even if the result of these developments is just greater corporate transparency, then it will help trustees undertake an analysis of where the value sits in the group and how easily it could be moved beyond the reach of the pension plan. The outcome of this analysis may be to agree a monitoring process or some preventative measures. If the impact of the trend is more dramatic and multi-national groups become less inclined to shift profits to lower tax jurisdictions, this may mean more profits remaining in the UK and the greater availability of funds for UK pension plans. Either way, this populist trend could be a rare example of a recent development which is making the role of a pension plan trustee a little easier.

Bringing UK “big business” into line: corporate governance reform

As trailed in our recent blog post, the green paper on the reform of corporate governance was published today by the Department for Business, Energy and Industrial Strategy (formerly BIS).  The paper sets out 14 questions for consultation.

The consultation covers three main areas:

  • executive pay, “which has grown much faster over the last two decades than pay generally and than typical corporate performance”;
  • strengthening the voices of employees, customers and wider stakeholders; and
  • corporate governance in large private companies (BhS springs to mind).

Executive pay

This takes the lion’s share of the questions.  Three are aimed at increasing the influence and engagement of shareholders in directors’ remuneration.  It is acknowledged that a binding vote on the remuneration report (as well as the existing binding vote on remuneration policy) could be tricky, since it would involve directors’ service contracts having to state that pay was conditional upon shareholder approval.  Views are sought on whether a binding vote should apply only to variable parts of the pay package (increase in salary, annual bonus and LTIP awards) or just to companies that have “encountered significant shareholder opposition to the remuneration report” (perhaps a vote against in the range 20% to 33% for the previous one or two years).  Alternatively, it is suggested that a remuneration policy must contain an upper threshold for all elements of pay and a binding vote at the AGM must be sought for any package that exceeds that threshold during the relevant year.  Another option is to make the remuneration policy subject to an annual vote (although it is admitted that this may encourage short-termism, which investors have all said they want to discourage), or to allow shareholders to require a binding policy vote sooner in the current three-year term in a case where the company’s circumstances change.  Finally the FRS could be asked to make the Corporate Governance Code more specific about how companies should engage with shareholders, particularly when there is a significant vote against the remuneration report.

One question asks whether more needs to be done to encourage shareholders to make more use of their votes, perhaps by making disclosure of institutional voting records mandatory, or by establishing a “senior shareholder committee” to scrutinise remuneration (whilst acknowledging that this would go against the UK’s long-established unitary board structure) and/or doing more to help individual investors to use their vote.

Suggestions for increasing the effectiveness of remuneration committees include requiring them to consult shareholders and the company workforce before formulating pay policy and requiring a director to have served on the committee for at least 12 months before becoming chair.

Then there is the vexed question of whether the ratio of the CEO’s pay to that of the “median employee” should have to be disclosed, as will be mandatory for US companies from January 2017 and as encouraged by the Investment Association in its recently-updated principles of remuneration.  Highlighted issues are “context is vital if ratio reporting is to add value” and the unintended consequence of encouraging companies to outsource or “offshore” their lower-paid employees.

The nettle of investors’ complaints about annual bonus targets not being disclosed is firmly grasped.  Certainly within the FTSE100 in the 2016 season, there was almost blanket reliance on the “commercial sensitivity” get-out allowed under the directors’ remuneration regulations, with most companies disclosing retrospectively the next year, some committing to disclose once the board considers the sensitivity has gone away and a very few saying never.

Finally in this section, should the release of LTIP awards be increased from a minimum of 3 years to 5 years?  This is currently encouraged by all investors’ guidelines and certainly within the FTSE100, there is already widespread compliance (albeit by varying routes), so this should be pushing at an open door.  Also, should “restricted shares” (annual share options with no performance conditions, just a requirement for the participant to remain employed) be used in preference to LTIP awards?

Strengthening the shareholder voice

Theresa May’s pledge in pre-PM days and since to have employee representation on boards has been largely watered down to questions as to how stakeholders, including employees, customers and other “interested parties”, can be given more say in board decisions, in particular how remuneration is structured.  Suggestions as to how this might be done include the creation of stakeholder advisory panels; the designation of a non-executive director (possibly a member of the remuneration committee) as the conduit to ensure that the views of interested groups, particularly employees, are put to the board; strengthening reporting requirements as to stakeholder engagement; and only as one option the appointment of stakeholder representatives to boards (acknowledging that election of representatives, potential conflict, delayed decision-making and confidentiality are challenges of this last approach and emphasising that this would not be made mandatory).  Ideas are invited as to which companies this should apply to – measured by number of employees or another size metric?  Should this aspect be legislative, code-based or voluntary?

Large private companies

According to the table of figures given in the paper, there are 33,000 private companies (excluding LLPs and subsidiaries of UK quoted companies) that have an annual turnover of more than £36 million or total assets of more than £18 million and 2,200 that have more than 1,000 employees.  Views are sought as to whether to strengthen the corporate governance regime applying to these companies, and if so, how – extend the Corporate Governance Code to them, or invite the FRC or the Institute of Directors to formulate a code specifically for them?  Which companies should be caught and what should be the size threshold?  Should non-financial reporting requirements for private businesses (for example, gender pay issues, modern slavery prevention, prompt payment practices), currently based on their legal form, be applied on the basis of a size threshold?

The deadline for responses is 17 February 2017.

Great Expectations: Hermes joins the fray on UK executive pay

Three publications over the last few weeks are particularly relevant for companies preparing their new remuneration policies for 2017 (including most of the FTSE100).

Hermes Investment Management recently published its “Remuneration principles: clarifying expectations“.  This is its first solo effort – it previously was part of a group of large investors who jointly published their remuneration principles in November 2013.  We understand that a draft of the paper was sent to the chairs of remuneration committees in September, presumably to be timely for their deliberations about renewing their remuneration policies.  Pretty radical stuff, this – the paper calls for a fundamental rethink of remuneration practices and a challenge to the level of executive pay packages.  As we have seen before, “much simpler, more transparent and less-leveraged” awards are encouraged.  The suggestion is even made of a move to paying nothing but entirely fixed remuneration, “based primarily on shareholdings, together with a cash salary similar to today’s levels”.  The remuneration committee should be more accountable and its chair should:

  • write annually to employees to explain the basis for the CEO’s pay in the context of the company’s and the individual’s performance; and
  • seek and take account of employee’s views on directors’ pay and report on this process in the remuneration report.

The other two releases were updates of existing guidelines.

As covered in more detail in our previous post, the Investment Association updated its Principles of Remuneration to reflect issues arising over the 2016 AGM season on which we have previously reported.  Amendments include:

  • less reliance by remuneration committees on consultants;
  • greater emphasis on sustainable business performance and designing structures which support the strategy of the company;
  • retention of their personal shareholdings even after directors leave the company;
  • a statement by the remuneration committee in the event of a (non-binding) vote of 20% or more against the remuneration report (we note that in the 2016 AGM season, some FTSE100 companies commented, and even amended their practice on grants, in response to smaller votes against);
  • a preference for outstanding awards to be rolled-over on a takeover, rather than become exercisable, and performance to date to be the determinant of the extent of early vesting; and
  • guarding against windfall gains as a result of changes in share price (particularly relevant in these times of high share price volatility since the Brexit vote).

Institutional Shareholder Services (ISS) also updated its proxy voting guidelines, effective for meetings from 1 February 2017.  In common with other guidelines, the amendments place increased emphasis on simplicity, long-termism, alignment with the company’s objectives and ensuring that rewards are not excessive, along with support for “companies to consider pay models which do not fully align with the typical structure found in the UK market” (head above the parapet, anyone?).  The head that should roll would be that of the chair of the remuneration committee, who should “be held directly accountable where major remuneration issues have been identified”.

Plenty for remuneration committees to think about then, with the gauntlet thrown down for them to step up to the plate (if that isn’t mixing metaphors too much).  It remains to be seen how many companies will be brave enough to think outside the tried and tested remuneration box ….

 

 

 

A brake on executive pay? More on employee representation on boards

Tucked away right at the end of Prime Minister’s questions yesterday, immediately before the Autumn Statement, was a very short question: “Does the Prime Minister believe that big companies should put a worker on the board?”  Given recent headlines such as “Theresa May backtracks on putting workers on company boards” (The Telegraph, 21 November) and “Theresa May: I won’t force companies to put workers on their boards” (The Guardian, 21 November), one might be forgiven for thinking that this was a planted question, perhaps indicating that the press had got hold of the wrong end of the stick on this issue.  But no, the question was from Gloria de Piero (Lab, Ashfield).

The background to this is of course the disquiet in the media and amongst the public about “excessive” levels of executive pay. Investors too are concerned, as shown by the numerous examples of significant votes (albeit non-binding) against the implementation of remuneration policies during the 2016 AGM season on which we previously reported.  Theresa May made pledges about corporate governance before she became PM, including not only having employee representatives on boards, but also making the vote on implementation of the remuneration policy binding.  The Business, Innovation and Skills Committee launched a corporate governance inquiry in September, focusing on executive pay.

Under the directors’ remuneration reporting regulations, companies are supposed to disclose what they have done to consult employees about executive pay packages.  In practice, usually this is either a blank or a statement that staff are not consulted, which doubtless has added fuel to the flames.

At the sharp end, there are definitely real problems with having employees on boards as pointed out in posts on our employment and corporate blogs.

The speech that generated the headlines on Monday was given by Theresa May at the CBI annual conference: “I can categorically tell you that this is not about mandating works councils, or the direct appointment of workers or trade union representatives on boards”.  The proposal was watered down to “ensuring employees’ voices are properly represented in board deliberations.”  A green paper has been promised later in the autumn “that addresses executive pay and accountability to shareholders, and how we can ensure the employee voice is heard in the boardroom.”

Odd then that the answer to The Question was “I believe that we should see workers representation on boards and … this government is going to deliver on that.”  Will they, won’t they?  We await the green paper with interest!

 

Salary Sacrifice and Termination Payments

Amongst a number of announcements relating to employment taxes in today’s UK Autumn Statement, forthcoming changes to the tax treatment of salary sacrifice and employee termination payments were confirmed.

The tax and National Insurance advantages of salary sacrifice schemes will be removed from April 2017 (i.e. the sacrificed pay will be subject to tax and National Insurance). Thankfully this will not apply to arrangements relating to pensions (including advice), childcare, Cycle to Work and ultra-low emission cars. All arrangements in place before April 2017 will be protected until April 2018, and arrangements in place before April 2017 for cars, accommodation and school fees will be protected until April 2021. This attack on salary sacrifice schemes appears harsh in principle but it was clear from the previous consultation that the government was committed to the change and the majority of salary sacrifice schemes will relate to the excluded benefits in any event.

The Chancellor also confirmed that from April 2018 termination payments over £30,000, which are subject to income tax, will also be subject to employer’s National Insurance. However, although as previously announced all PILONs will be fully taxable and NICable from April 2018 irrespective of whether there is a PILON clause in the contract, the government has adjusted its proposals in this regard following consultation. Rather than the taxable PILON amount including all compensation for benefits and bonus that would have been received during the unworked notice period, tax will only be applied to the equivalent of the employee’s basic pay for the unworked notice period. This is a sensible adjustment – the previously announced approach would have involved a number of unnecessary complexities (e.g. deciding how much bonus the employee might have received during the unworked notice period).

Employee shareholder status

The UK government has announced the abolition of the tax benefits of employee shareholder status in today’s Autumn Statement. The change applies to shares issued on or after 1 December 2016. Since there has to be a minimum 7 clear days notice between the individual employee being advised on the implications of employee shareholder status and the issue of the shares, this effectively means that unless employees have already received that advice, no further issues of ESS shares will be possible from today.

ESS shares have offered significant tax advantages to employees. In particular, gains realised on the sale of ESS shares have been free of capital gains tax, although a cap on this was introduced in the March Budget (which was an indication that the tax breaks might be on borrowed time). In addition, the first £2,000 worth of ESS shares were free of income tax when received by an employee. In exchange for these tax breaks, employees were required to contract out of various employment law rights, including the ability to claim unfair dismissal.

The original intention was for ESS shares to be used to provide employee shares to a wide range of staff. However, their use has generally been limited, not least by the restrictions around how they are issued to employees, so that in practice the benefits have been confined to a few members of senior management, often in the context of a private equity or venture capital transaction. This restricted use of ESS is the justification given by the government for today’s announcement.

On the plus side, existing ESS shares are unaffected and, in particular, will continue to benefit from the CGT exemption.

Budgeting for UK employee healthcare costs

We anticipate that the significant increase in insurance premium tax that was announced in the 2016 Autumn Statement will encourage many more employers to explore corporate healthcare trusts. IPT will increase from 10% to 12% from June 2017, having been as low as 6% just over a year ago. This will apply to employee health insurance policies as it does to all other UK insurance products. Corporate healthcare trusts are a way of providing healthcare benefits to employees other than through insurance. Instead of paying premiums to an insurer, the employer pays cash into a trust for the benefit of its employees. The trustees then pay for medical treatment or reimburse employees for medical expenses incurred. As insurance based arrangements become more costly, the alternative of corporate healthcare trusts becomes increasingly attractive and will start to feature more and more on the FD’s wish-list!

What a relief – no more changes to pensions tax relief (and no more Autumn Statements)!

Save for confirmation of a ban on cold calling and a reduction in the Money Purchase Annual Allowance, the UK Autumn Statement included no pension reform to the great relief of an industry in desperate need of a period of stability.

The pension system was the cookie jar into which George Osborne kept dipping. Barely any aspect was left untouched during Osborne’s 6 year tenure. The state pension changed dramatically in April 2016 and, with the Cridland report at only interim report stage, it was perhaps too early for further changes to be announced. Public sector pensions have been through a recent restructuring and earlier this year public sector employers saw the cost that they pay the Treasury to subsidise these arrangements increase by £2bn per annum when discount rates were reduced. Again it was too soon for these arrangements to be revisited.

That just left occupational and private pensions. Again Hammond’s predecessor was very active in this area. 2015 saw the introduction of much wider freedom and choice for over 55s in terms of how they access their pension savings. Meanwhile the tax relief available to pension savings has steadily reduced with further cuts in April 2016. The Chancellor resisted any temptation to announce more freedoms or additional cuts to tax relief and refrained from revisiting other proposals that had previously been put in the too difficult pile (e.g. a single rate of pension tax relief or cut backs on pension salary sacrifice). Instead he did something that Osborne never seemed to manage and left pensions well alone!

Time out: trustee cannot appeal prohibition from acting as pension plan trustee

The UK Pensions Regulator has power to prohibit a person from acting as a pension plan trustee. When it does so, the reputational consequences for the individual can be severe and go beyond the pensions sphere. In 2011, three trustees of a pension scheme were prohibited from acting as trustees of any occupational pension plans. The basis of the prohibition was the trustees breaching pension investment legislation and failing to manage conflicts of interests.

The Regulator made the prohibition order under a Determination Notice in October 2011. Following the DN, the trustees’ names were published on the Regulator’s website. The Regulator’s list includes those individuals it does not consider are ‘fit and proper persons’ to act as trustees of occupational pension plans.

The trustees had 28 days from the issue of the DN to appeal it to the Upper Tribunal, but none of them did so within that timescale. However, in September 2016 one of the trustees (Mr X) asked the Upper Tribunal for permission to appeal despite being well outside the 28 day period.

Mr X argued that he had suffered reputational damage. This arose from his prohibition together with other allegations of fraud and criminality (which were never established). He said that, as a result, banks were not willing to lend to him capital to set up a new business and would not accept him as a director of a new company.

The Upper Tribunal decided that Mr X could not now appeal the Regulator’s DN. This was because:

  • Court time limits serve a public interest and the interests of other parties have to be considered.
  • The 4 year 9 month delay was clearly significant.
  • Mr X’s reasons for the delay were not enough to overcome other factors.  He was busy facing separate civil proceedings at the time the DN was issued, which also led to stress and anxiety. However, he could still have appealed the DN and then applied for the decision to be postponed until the civil proceedings were resolved. He ought to have been aware that there was no fee required to appeal the DN.
  • The consequences for the Regulator, if the Upper Tribunal were to extend the time allowed for an appeal, were important given its limited resources.
  • The consequences for Mr X, of the Upper Tribunal refusing to extend time, were limited. Mr X could still apply separately for the prohibition order to be revoked, just not by appealing the original decision. Mr X’s arguments about his change of circumstances would still be relevant to an application to revoke the prohibition.

This case shows the importance of keeping to Court deadlines. While the Court will extend time limits in some circumstances, it is taking an increasingly strict approach. Strong reasons must be produced for extending time limits. In this case the public interest took priority, in terms of preserving both the finality of litigation and the Regulator’s limited resources.

The case also highlights practical risks to individual trustees who can face considerable personal consequences from a prohibition order.

Confusion reigns on CPI?

CPIH is to become the preferred method of UK consumer price inflation from March 2017, according to a statement issued by the National Statistician on 10 November 2016. This follows a wide-ranging and long-lasting process of consultation and consideration. But what will be the impact on UK pensions?

Pension inflation measures have been in the news a lot recently (see this Pensions Expert report). In July the gap between CPI and RPI grew to its highest level for 5 years, with the 1.3% disparity a particular concern for the sponsors of pension plans that have RPI hard-wired into their rules.

The prospect of an appeal in the Barnardo’s case gave a crumb of comfort to those employers who were hoping that RPI could be treated as “replaced” even though it continues to be published. However, the Court of Appeal judgment in November upheld the earlier decision that as long as RPI exists it has not been replaced.

Now, we finally have some output from the consultation on consumer prices that closed over 12 months ago. In summary:

  • CPIH (which includes an element of housing costs) will become the preferred measure of consumer price inflation from March 2017, giving it a higher status than CPI.
  • RPIJ (a variant on RPI) will cease to be published from March 2017, but RPI will continue to be published given that it continues to be used very widely.

The main pension question arising from the statement is whether CPIH will replace CPI as the statutory basis for pension inflation. The BBC reports that the Treasury has no plans to adopt CPIH for pension uprating purposes, but former Pensions Minister Steve Webb has said on social media that CPIH should now be used by the Treasury for these purposes.

As CPIH is typically higher than CPI, it would add to the cost of pension provision and therefore frustrate the sponsors of plans who have been able to move to CPI. However, the reduced gap with RPI may lessen the blow for sponsors of plans that are stuck with RPI.

What binds all interested parties together is a desire for certainty, and so it would be helpful for the Treasury to make a public statement on the issue, either in this month’s Autumn Statement or otherwise

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