Variable remuneration in the UK

AutorVictoria Goode/Anna Bond
CargoPartner - Head of Reward Practice at Lewis Silkin LLP/Employment Associate at Lewis Silkin LLP
Páginas150-178

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1. Introduction

In an increasingly challenging business environment, employers need to ensure that they have a competitive remuneration package to attract, retain and incentivise key emplo-yees. In the UK, most employers use some form of variable remuneration to try to achieve this.

Generally UK employers have significant flexibility in structuring their variable remuneration arrangements. For example employers generally have freedom to decide whether the variable remuneration should be discretionary or contractual, the performance condi-tions that should be applied, the period over which performance should be measured and how leavers should be treated. That said, companies Usted on the London Stock Exchange («LSE») and firms in the financial services sector have to take into account the require-ments of regulators and the expectations of shareholders; those requirements and expec-tations affect the structure and timing of variable remuneration and, for banks and certain other investment firms, quantum.

This article provides an introduction to the structure of variable remuneration in the UK and examines current trends in the use of variable remuneration. It also considers a number of legal issues in relation to variable remuneration including its regulation in companies listed on the main market of the LSE («FTSE 350 companies») and banks, the different types of performance conditions and other legal issues relating to bonuses, including how bonuses may become contractual through an employers conduct and potential issues with discrimination and holiday pay.

2. What is variable remuneration

In this article «variable remuneration» means any payments or benefits (including for example cash bonuses, commission and share incentives), receipt of which is depen-dent on the satisfaction of performance conditions or other contractual criteria such as remaining in employment until a certain date.

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European legislation -most notably the Capital Requirements Directive (2013/36/EU) («CRD»)-draws a distinctionbetween «variable remuneration» and «fixed remuneration»1. It seems implicit within those definitions that variable remuneration should be used to reward employees for extraordinary performance (i.e. for «going the extra mile» rather than simply doing the job.) In practice, in the UK in many sectors, cash bonuses are an expected element of the employees remuneration package and, in some circumstances, have traditionally been used to supplement a low base salary.

For companies listed either on the main market or the Alternative Investment Market («AIM») of the LSE, variable remuneration in the form of shares is an essential part of the remuneration package to ensure that the financial interests of employees, particularly sénior executives, are aligned with those of shareholders. Most listed companies also opérate a share plan for all employees.

We examine the main ways in which variable remuneration is structured in Section 3 below, and the type of performance conditions that may be imposed in Section 7 be-low.

3. How is variable remuneration structured?

In the UK, variable remuneration is delivered either in cash, in shares or other owners-hip interests in the employing group, or a mixture of both.

It is a common saying in the UK that «cash is king»! In other words, employees gene-rally favour cash over shares and, when provided with shares, will often seek to sell those shares as soon as they are permitted to do so in order to raise cash.

However,cash bonuses have an immediate effect on the employer's cash-flow. In addi-tion, cash bonuses do not attract any favourable tax treatment, they are subject to in-come tax and employee and employer social security contributions -known as national insurance contributions («NIC»)- in full when received, in the same way as salary. In contrast, successive governments have taken the view that encouraging equity incentives may improve the general economy. Tax legislation (principally the Income Tax -Earnings and Pensions- Act 2003) contains specific employee share plans that benefit from valuable

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tax reliefs. Often share plans can be structured so that the growth in valué of the shares is subject to capital gains tax (generally at 20% for disposals after 5 April 2016) rather than income tax and NIC. Depending on the level of the employee's income, income tax may be 45% with employee NIC at 2% and employer NIC at 13.8%.

There are a number of other reasons why an employer may want to introduce an employee share plan instead of, or in addition to, a cash plan including:

• Wanting to move towards collective ownership -i.e. giving employees a say in the com-pany going forward; and/or

• Enabling employees to participate in the growth in valué of the company; and/or

• Aligning the interests of employees, particularly sénior executives,with those of sha-reholders to consider the best interests of shareholders in their management of the business.

Examples of the main forms of cash and share based variable remuneration commonly used in the UK are summarised below.

3.1. Annual cash bonuses

There are two broad categories of annual cash bonus: a non-contractual or a contractual bonus.

A non-contractual bonus scheme will typically provide that there is no right to a bonus, but that payments may be made entirely at the employer's discretion and on the employer's own terms. The key aim is to avoid placing the employer under any obligation to make any bonus payments. Most employers will prefer to offer a non-contractual bonus as this gives them greater flexibility.

Contractual bonuses are calculated upon whatever basis is set out in the scheme. Annual bonuses are typically expressed as a target percentage of the employee's salary and plans are typically constructed to provide threshold, target and máximum levéis of performance which then genérate corresponding threshold, target and máximum levéis of pay-out.

It is worth noting that many employers, particularly listed companies, may require employees to defer some or their entire annual bonus into shares. This is sometimes accom-panied by the promise of receiving free, additional matching shares from the company if performance and continued employment conditions are met.

Legal issues relating to contractual and non-contractual cash bonuses are discussed further in Section 7 below.

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3.2. Long-term cash incentive plans

Long-term cash incentive plans are a form of award which is contingent upon the achie-vement of previously defined performance objectives over a multi-year period (typically at least three years). Again, a long term cash incentive plan may be structured either as a non-contractual or a contractual bonus.

3.3. Phantom share plans

This is a particular type of cash bonus, the valué of which is linked to the increase in the valué of the company's shares. However, no shares are actually issued or transferred to employees.

Phantom share plans are often used by private companies to grant awards to employees that mirror share options or restricted share plans, in circumstances where using actual shares is inappropriate, for example where shareholders are concerned about the dilution of their shareholdings or control.

3.4. Specific purpose bonus

Some bonuses are awarded for a specific purpose to incentivise the employee to perform a certain objective or for a specific event such as a sign on bonus given to a newly hired employee.

3.5. Commission

Commission is remuneration based on the amount of sales an employee makes and is typically paid as a percentage of those sales. Commission is often used to supplement a low base salar y.

There are two basic ways of calculating commission: fíat commission and ramped commission. Fiat commission is calculated at a fíat rate whereas ramped commission increases on the attainment of certain goals or targets.

3.6. Tax-advantaged equity plans

These types of plans can be very tax efficient for both a company and its employees. However, to obtain that tax efficiency there are a number of statutory requirements (regarding for example the company that offers the plan, the shares that can be used, the employees

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that can particípate and the limits on participation) which must be satisfied. Tax-advantaged arrangements are classified by the employees that are able to participate in them. Some types of tax-advantaged plans have to be made available to all qualifying...

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