Remuneration Winter update 2024

19 February 2024

Welcome to the winter 2024 edition of our remuneration and share plans update in which we review the latest developments in executive remuneration and share plans.

FRC’s changes to the Corporate Governance Code

Following its consultation, as mentioned in our 2023 Summer Update, the UK’s Financial Reporting Council (FRC) has now published its UK Corporate Governance Code 2024 (the 2024 Code), replacing the 2018 Code. Following the FRC’s announcement in November 2023, only a small number of the original proposals set out in the May 2023 consultation document have been incorporated into the new Code.

The 2024 Code will generally apply to financial years beginning on or after 1 January 2025. The few changes to the provisions dealing with executive pay are summarised below.

Malus and clawback

Directors’ contracts and remuneration arrangements are now expected to include malus and clawback provisions as a standard feature (Provision 37). For the vast majority of UK listed companies, malus and clawback provisions in incentive plans have been the norm for many years.

Provision 38 requires companies to set out in their annual directors’ remuneration report details of:

  • the malus and clawback provisions that apply;
  • the circumstances in which these can be used;
  • the period the provisions apply for (as well as details of the rationale for choosing this period, including why it is appropriate for the particular company);
  • the practical application of the provisions during the prior year and over the last five years; and
  • if the provisions have been used in the last reporting period, a clear explanation of why.

Factors informing remuneration policies and practices

Provision 40 provides that companies are no longer required to include a description of how the remuneration committee made decisions on remuneration with regard to the six factors set out in the 2018 Code (namely, clarity, simplicity, risk, predictability, proportionality and alignment to culture). The FRC feels that a less prescriptive Code will allow for a more flexible narrative and potentially enable companies to adopt a streamlined reporting process.

Enterprise management incentive option deadline extended

Following the Government’s call for evidence on enterprise management incentive (EMI) schemes in the 2021 Budget, the administrative requirements surrounding the granting of EMI options have been subject to changes aimed at streamlining that process.

Two previous significant changes have been the removal of the requirement to sign a working time declaration and the requirement to set out details of share restrictions in option agreements, applicable from 6 April 2023.

Draft legislation has now been published containing a proposal to revise the EMI legislation to extend the time limit to submit notification of EMI option grants.

The current position is that companies must notify HM Revenue and Customs (HMRC) of the grant of an option within 92-days of such grant. For options granted on or after 6 April 2024, this time limit will be extended to allow companies to notify EMI grants to HMRC on or before 6 July following the end of the tax year in which the grant was made.

For options granted prior to 6 April 2024, the 92-day notification deadline will still apply. If options are not notified within the current 92-day timeframe, those options will not qualify as EMI options.

It is expected that this change will enable more companies to avoid late notifications, and therefore increase the number of EMI options that are qualifying and deliver more value to eligible employees.

HMRC’s employee benefit trust consultation

The Government was seeking views on proposals to reform the tax treatment of certain inheritance tax (IHT) exemptions available to employee benefit trusts (EBTs) that meet certain requirements.

HMRC have published a consultation summary in which they emphasise that the policy objective of EBTs is the incentivisation by companies of a wider class of employees.

In publishing the summary, HMRC have reviewed the arrangements by which an EBT may meet the conditions set out in section 86 of the Inheritance Tax Act 1984 (the Act). If the EBT meets the requirements under the Act, it will get relief from IHT charges of up to 6% at each ten-year anniversary of the EBT being set up, plus any exit charges on capital distributions from the EBT.

Additionally, transfers into an EBT that meet conditions set out at section 28 of the Act are exempt from IHT where there is a transfer of shares or securities in a company by an individual.

HMRC have concerns that EBTs are being structured as compliant with the Act but are then not used to incentivise the wider class of employees, but rather to distribute capital to shareholders in the company (participators) or to those connected with participators.

Dealing with those concerns, the following issues and proposed solutions have been put forward by HMRC.

  • Issue: one of the requirements for favourable IHT treatment is that individuals connected to a participator in the company cannot benefit from the trust. However, HMRC have seen cases where the trust deed allows individuals connected to a participator to benefit after the participator’s death.
  • Proposed solution: the Government proposes to make it explicit that restrictions on persons connected to the participator benefitting from the EBT must apply for the lifetime of the EBT.
  • Issue: an individual sets up a company, transfers shares into an EBT and then obtains the IHT exemption immediately.
  • Proposed solution: the Government proposes introducing a rule whereby the settlor of the EBT must have held the shares they transfer to the EBT for at least two years prior to such transfer in order to gain exemptions under the Act.
  • Issue: under current legislation, participators and those connected to them are allowed to benefit from income payments made by the EBT.
  • Proposed solution: in response to this, the Government also seeks to introduce a new requirement that no more than 25% of employees who benefit from income payments under an EBT can be connected to the participator.

The consultation closed on 25 September 2023.

Diversity and inclusion in financial services

The PRA and FCA have issued a consultation paper on a new regulatory framework for diversity and inclusion (D&I) in the financial sector. The framework aims to establish minimum standards, clarify expectations and improve transparency on D&I across the sector, as well as to support the FCA's objectives of consumer protection, market integrity, competition and growth.

The framework consists of proposals that apply to all in-scope firms (namely most FCA or PRA regulated firms), and additional proposals that apply only to large firms (defined as those with 251 or more employees).

The proposals that apply to all in-scope firms are generally as follows.

  • Non-financial misconduct: the consultation paper explains how existing rules on fitness and propriety, conduct and threshold conditions apply to issues such as bullying and harassment, and how firms should take action and report such issues to the regulators. The rationale for this proposal is to give firms confidence and consistency in dealing with non-financial misconduct, which can undermine trust, culture and performance in the sector.
  • Employee number reporting: all firms must report their employee numbers annually to the regulators, so that they can monitor the scope and proportionality of the framework. The rationale for this proposal is to ensure that the framework is applied appropriately and effectively to firms of different sizes.

The additional proposals that apply to large firms are as follows.

  • D&I strategies: large firms should implement a D&I strategy that sets out their objectives, plans and governance arrangements for D&I. This proposal is intended to drive strategic focus and enable scrutiny of D&I outcomes and practices in the sector. The consultation paper provides flexibility for firms to design their own strategies, but expects them to cover certain aspects such as leadership, culture, policies and processes.
  • Target setting: large firms should set targets to address underrepresentation of certain characteristics in their workforce, at least one for each of the following levels: board, senior leadership and all employees. The rationale for this proposal is to encourage firms to take action and measure progress on D&I, and to recognise the benefits of diverse representation for decision-making, innovation and consumer outcomes. The consultation paper allows firms to decide which characteristics and levels to target, but expects them to be relevant, ambitious and realistic.
  • Data reporting and disclosure: large firms must report and disclose diversity data annually, covering both quantitative and qualitative aspects of D&I. The idea here is to improve transparency and consistency of D&I information in the sector, and to enable benchmarking, accountability and engagement. The consultation paper specifies the data that firms must report to the regulators, such as the breakdown of employees by protected characteristics and the staff inclusion measures, and the data that firms must disclose publicly, such as the diversity of their board and senior leadership.
  • Governance: large firms must treat lack of D&I as a non-financial risk, and ensure that relevant functions, such as risk, compliance and internal audit, help embed D&I practices and provide oversight. This will support sound governance and risk management in the sector and challenge poor D&I practices and outcomes.

The consultation paper plans to publish the final rules in 2024, giving firms 12 months to comply with the framework.

New employer withholding obligation on options in Ireland

The Irish Government’s Finance Bill (published in October) contains a previously unannounced change which will bring share options within employer payroll withholding obligations under the Pay As You Earn (PAYE) system for the first time. The change will apply to all option exercises that occur on or after 1 January 2024.

At the moment, in Ireland, it is the employee’s responsibility to navigate the relevant tax on a share option exercises (RTSO) procedure to report any gain realised on the exercise of their share options and remit the income tax, USC and employee PRSI arising, within 30 days of the date of exercise. Employees also must file a tax return for the year in which exercise occurs, under self-assessment rules. Failing to comply with timely and correct filings and payments of tax can leave the employee open to both interest and penalty payments.

Going forward, employers are required to ensure that their payroll function is fully integrated with their share option exercise procedures so that payroll providers receive details of all share option exercises in a timely manner. Employers do already have to report share option grant and exercise information annually to Revenue on Form RSS1 but the new payroll obligation means employers now have a more active role to play in tax compliance.

The changes will bring share options into the PAYE withholding regime in line with taxes on all other forms of share-based remuneration, such as restricted share units and free or discounted shares, and so is not surprising. It will also bring Ireland in line with withholding obligations in many other jurisdictions, including most European countries, the US and the UK.

Bankers’ bonus cap is scrapped

The PRA and FCA issued a joint policy statement (the PS) on 24 October 2023 setting out details on the removal of the limits on the ratio between fixed and variable pay (bonus cap) for banks, building societies, and PRA-designated investment firms. Some of the key issues addressed in the PS are as follows.

  • Timing of removal of the cap. The regulators have decided the removal of the bonus cap will apply to firms' ongoing performance year from 31 October 2023 (when the changes to the PRA's Rulebook and the FCA's Handbook would enter into force). This is a change from the next performance year as originally proposed. The reason for the change is to give firms more flexibility to restructure pay faster and to compete more effectively in the international market, while still subjecting variable pay to risk adjustment and alignment with long-term performance.
  • The treatment of guaranteed variable remuneration. The PRA has decided to reinstate a provision in its guidance on remuneration (paragraph 5.33 in SS 2/17) whereby it expects firms to include guaranteed variable remuneration in the variable component of the fixed to variable ratio and to apply the deferral, malus, and clawback rules to this element. This will maintain the current approach of the PRA, which differs from the EBA guidelines that allow firms to exclude guaranteed variable remuneration from the calculation of the ratio and to not apply the risk adjustment rules to this element. The FCA also reminded firms that they are required to continue to apply the EBA guidelines "to the extent they remain relevant", notwithstanding that the content of the EBA guidelines that relates to the bonus cap will no longer remain relevant after the removal of the cap rule from the FCA's Handbook.
  • The wider reforms. The regulators noted that some respondents commented on the deferral periods and other aspects of the remuneration regime that are beyond the scope of the current consultation. The PRA indicated that it intends to look more broadly at the whole structure of rules around remuneration and to consider how these rules can be streamlined and made more effective and proportionate. The FCA also indicated that it may consider a wider review of its remuneration regime subject to its strategic priorities.
Vermillion – Supreme Court decision on the "deeming rule"

While the basic definition of when a security is employment-related has not caused much uncertainty to date, as the trigger of being acquired “by reason of” employment under s. 421B(1) of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) is well understood, there has been uncertainty as to the effect of the “deeming rule” in s. 421B(3) which provides that an acquisition is to be regarded as occurring by reason of employment where the right or opportunity is made available by a person’s employer or a person connected with a person’s employer.

To date, an inconsistent approach on the interpretation of the deeming rule has been somewhat encouraged by the fact that in some instances it suits a taxpayer for a security to be ERS whereas in other situations it does not.

In Vermillion Holdings Ltd v HMRC [2023] UKSC 37, the UK Supreme Court considered the application of the deeming rule and ruled in favour of HMRC in a tax dispute involving the exercise of a share option by a director of a software company. The court held that the option was an employment-related securities option under ITEPA on the basis that the deeming rule applied and therefore the option gain was subject to employment income tax.

The court rejected the notion that that the option was not made available by reason of the director's employment, but rather as a result of his surrender of a previous option that he had acquired before he became an employee. It was held that the employer conferred by contract the option to the director while he was an employee. The previous option was cancelled and a new option over a different and new class of shares was granted. On the question whether the surrender of the previous option meant that the employer did not make the new option available the Supreme Court said that this was not the case as that argument “addressed a question of causation and not the question as to who conferred the [new] option.

The court found that the purpose of the deeming provision was to avoid the difficult question of causation that may arise under s. 421B(1) of ITEPA ("by reason of”) which requires a link between the option and the employment. The purpose of the deeming rule in s. 421B(3) is to set out an objective “bright line” “by whom” test, i.e. the deeming rule should be the starting point, as, if it applies, there is no need to delve into the more nuanced questions of causation. The court concluded that the option in question was granted to the director at a time when Vermillion was his employer and was therefore employment-related.

Although it is clear from the decision that is not possible to escape the deeming rule by arguing that the employment was not the reason for the acquisition, there still remains two routes out of ERS status where the deeming rule could potentially apply. These are where (i) it may be considered that the right or opportunity to acquire the securities was not in fact made available by the employer or a person connected with the employer but by some other persons or body of persons; and (ii) the application of the deeming rule provision would produce an unjust, absurd or anomalous result. While the court did not consider the circumstances in which the application of the deeming rule would be unjust, absurd or anomalous in this case (although they must have considered that this was not the case on Vermillion’s facts), in our view, it is conceivable that in some circumstances in which there is no real link with employment, applying the deeming rule would indeed result in an unjust, absurd or anomalous outcome. Finally, the decision leaves open the question as to whether the deeming rule applies to a prospective employment where the relevant option or award is not granted “by reason” of that prospective employment.

The Macfarlanes tax and reward team have undertaken a detailed analysis of the case and its implications for employers. If you would like a copy, please let us know.

Save as you earn bonus rates

HMRC announced the latest SAYE savings contract bonus rates in their Employment Related Securities Bulletin 53. These rates apply to invitations made on or after 18 August 2023, and follows the changes to the mechanism for calculating SAYE bonus rates. The applicable rates are now:

  • for three year savings contracts, 1.1 multiplied by the employee's monthly savings contribution;
  • for five year savings contracts, 3.2 multiplied by the employee's monthly savings contribution; and
  • for early leavers, the interest rate will be 1.42%.
Court decision on right to participate in share incentive plans after TUPE transfer

The Court of Session, in its decision Ponticelli Limited v Gallagher [2023] CSIH 32 (15 August 2023), has recently dismissed an appeal by an employer (Ponticelli) who argued that it was not obliged to provide a share incentive plan (SIP) to an employee (Mr Gallagher) whose contract of employment had transferred to it under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). The court held that Mr Gallagher’s right to participate in a SIP operated by his former employer was a right "in connection with" his contract of employment and therefore transferred to Ponticelli, as his new employer, under TUPE. This decision has important implications for investors who buy the business assets of UK companies which operate SIPs or similar plans for their employees.

A SIP is a tax-advantaged all-employee share plan that allows employees to acquire shares in their employer or a group company, usually funded in part by deductions from their salary. SIPs can be attractive to both employers and employees as they can align the interests of the workforce with the performance of the business and provide tax benefits for both parties. However, SIPs can also create complications when a business is sold or transferred to a new owner, as the case of illustrates.

In Mr Gallagher’s case, he had entered into a separate contract with his former employer and the trustees of the SIP, which allowed him to purchase partnership shares and receive matching and free shares from his employer. The SIP was not mentioned in his contract of employment and was also open to other individuals who were former (not just current) employees of Mr Gallagher’s former employer, so long as they had been employed for at least three months in the same group of companies and were also UK resident for tax purposes. When Mr Gallagher’s contract of employment transferred to Ponticelli under TUPE, his participation in the SIP ended and the shares held on his behalf were transferred to him. Ponticelli offered him a one-off payment as compensation for the discontinuation of the SIP, but Mr Gallagher refused and claimed that he was entitled to be a member of a SIP of substantial equivalence or comparable value to the one operated by his former employer.

The Employment Tribunal and the Employment Appeal Tribunal agreed with Mr Gallagher and held that his right to participate in the SIP was a right "in connection with" his contract of employment and therefore transferred to Ponticelli under TUPE. Ponticelli appealed to the Court of Session, relying on an earlier case of Chapman v CPS Computer Group, where the Court of Appeal had held that a share option scheme was not affected by TUPE because it was a separate contract and not part of the employment relationship. However, the Court of Session rejected this argument and distinguished Chapman on the basis that it was not concerned with the interpretation of TUPE but with the meaning of "redundancy" in the context of the share option scheme.

The court also followed later authorities that had given a wide construction to the phrase "in connection with" the contract of employment in TUPE and found that the SIP was an integral part of Mr Gallagher’s overall financial package and arose directly from his status as an employee. The court also rejected the argument that the TUPE regulations went beyond the scope of the EU directive that they implemented, as the directive also referred to rights and obligations arising from the employment relationship, not just the contract of employment.

The decision of the Court of Session confirms that TUPE can apply to rights and obligations that are not expressly contained in the contract of employment but are sufficiently connected to the employment relationship, such as SIPs or similar share plans. This means that buyers in business sales by UK companies which operate SIPs or similar plans for their employees need to be aware of the potential liabilities and obligations that they may inherit under TUPE.

The main risk following Ponticelli is that the buyer may have to provide a substantially equivalent or comparable plan to the transferred employees, or face claims for compensation or breach of contract. As well as potentially incurring significant costs, this could practically be particularly problematic if the buyer, in its capacity as a transferee employer, does not currently or is not able to, because of its corporate structure or ownership, offer such types of plans. Alternatively, they may have to negotiate with the seller or the employees to agree on a suitable arrangement for the termination or continuation of the relevant plan. In any event, investors should conduct due diligence on the existence and terms of all share plans in which TUPE transferring employees participate to scope out the potential risks and liabilities upon transfer.

Employment tax update roundup

Basis period reform

The basis on which HMRC calculate taxable profits for sole traders and partners is changing to align with the tax year (tax year basis) rather than being based on the accounting year end ending in a tax year (current year basis).

From 2024/25, a business’ profit or loss for taxation purposes will be the profit or loss arising in the tax year itself, regardless of the business’ accounting date. 2023/24 is considered the transitional year where all businesses will transition to the new basis period rules and all outstanding Overlap Relief will be given. This will affect tax returns to be submitted by 31 January 2025.

Self-assessment tax returns

Individuals who are required to file a self-assessment tax return for the 2022/23 tax year had until 31 January 2024 to make their online submission. Those required to submit a return include (but are not limited to) individuals with trading income in excess of £1,000 and individuals with employment income taxed via PAYE of more then £100,000. For the 2023/24 tax year, the employment income threshold is being increased to £150,000.

As a reminder, individuals who worked from home during the Covid-19 pandemic (i.e., in the 2020/21 and 2021/22 tax years) but did not claim working from home relief, can backdate a tax relief claim on their self-assessment tax return. The deadline for claiming relief for the 2020/21 tax year is 2024/25 (i.e., in the self-assessment tax return due on 31 January 2026). It is worth noting that it was possible to apply to HMRC for relief via the Government gateway portal and HMRC would subsequently amend the requesting individual’s tax code. Before any backdated relief claim is made, taxpayers should ensure relief has not already been given.

To help non-domiciled individuals claiming the remittance basis of taxation, HMRC have introduced a new remittances toolkit which non-domiciled individuals can use when filing their 2022/23 self-assessment tax returns. The aim of introducing the toolkit is to ensure non-domiciled individuals understand (i) HMRC’s expectations with regards to reporting taxable remittances, (ii) the benefits of fully engaging with in the reporting process, and (iii) the potential consequences of not engaging such as the cost of HMRC enquiries.