Companies try to avoid 50% top tax rate by altering pay policies

Big companies construct complex schemes that risk infuriating the government as it tries to crack down on tax avoidance

Britain’s leading companies are devising pay schemes that enable top executives to escape the new 50p rate of income tax for high earners that takes effect in April, the Guardian has learned.

Some of the biggest companies in the country are constructing complex pay schemes that risk infuriating government ministers, who are determined to crack down on tax avoidance. Some of these schemes are “nakedly” intended to allow senior boardroom bosses to pay a tax rate of 18% instead of the 50% top rate, according to one industry expert.

The new schemes have come to light only weeks after Alistair Darling announced a new supertax on bankers’ bonuses in the pre-budget report amid growing public anger about top pay.

The plans for complicated pay policies are being presented to senior institutional investors in the City who are briefed each year by remuneration consultants about pay schemes for major companies. Investors vote on executive pay schemes in an advisory capacity, but most companies try to gain their biggest shareholders’ approval for pay changes.

Many investors had been braced for proposals that would have allowed boardroom executives to enjoy rises in their base salaries, which were largely frozen during 2009 because of the onset of the recession. However, they have found that the plans they are being asked to consider are extremely complicated and are being constructed to adapt to the changing tax environment from April when the government has announced income tax for high earners will rise.

Peter Montagnon, head of investment affairs at the Association of British Insurers whose members control a fifth of the stock market, said: “We have noticed a lot of interest in tax efficiency. This is liable to produce some very complicated share schemes which shareholders will have to scrutinise closely.”

When it was announced in April, the government said the new 50% band will be levied on the estimated 350,000 people with incomes above £150,000 a year – easily capturing the executives in the boardrooms of Britain’s biggest companies.

A number of pay plans are currently on the drawing board and differ subtly from the current schemes used in Britain’s biggest boardrooms. Many of them seek to re-classify executives’ income as capital gains which attract a lower tax rate.

Most pay schemes for FTSE 100 executives are currently based on awards of shares or options that are linked to performance criteria over three to five years. The income tax is paid when the shares or options actually vest – when the executive gains control of them.

But the new schemes being drawn up are based on a system known as restrictive stock. These seek to shift most of the tax liability to a capital gain on any profits made at the end of the three- to five-year period when the shares vest.

They use complicated financial instruments to minimise the income tax paid by the director when the stock is received and transfer some of the economic risk to the executive. While shareholders are not able to formally veto pay practices they dislike, they have a vote on remuneration reports at companies’ annual general meetings (AGMs) each year although the outcome is only advisory.

Jon Terry, head of remuneration at PricewaterhouseCoopers, said: “A number of these restrictive stock-type arrangements will come forward this AGM season.”

Montagnon is also warning major companies that shareholders are unwilling to endorse pay plans which are overly complicated and purely designed to pass on the cost of the extra tax to the company from the executive who might otherwise be liable.

“We can’t support schemes which end up costing the company more than would otherwise have been the case or simply shift the tax burden from the individual to the company. Shareholders recognise that schemes should be efficient in relation to tax implications, but there is a limit. Shareholders cannot support schemes which are nakedly for the purpose of avoiding tax,” he said.

Darling’s new supertax on bonuses led to threats that star bankers would leave the UK to live and work in countries with less punitive tax regimes. He announced this month that the tax would become effective immediately, last until the end of the current tax year in early April and be paid by banks on bonuses over £25,000.

While it has been subjected to some refinements by HM Revenue & Customs, including clarifying the definition of a “bank”, the government is determined to press on with the payroll tax on bonuses and made clear it intends to clamp down on any avoidance techniques – such as deferring payments beyond the tax year.

Banks and City traders have earned a reputation for tax avoidance. Earlier this year, Royal Bank of Scotland found itself in court having to defend the way commodities traders in its Sempra division were being paid to avoid income tax and national insurance contributions. Sempra, now up for sale by the bank in which the taxpayer has a 84% stake, has also paid traders in jars of platinum sponge, a valuable greyish-black metal, or in gold bullion.

Bad year: Shareholders revolt over pay

At least five companies endured embarrassing defeats for their remuneration reports in 2009, in what was a record year for shareholder revolts, and no more so than at Royal Bank of Scotland, which recorded the largest defeat yet for an executive pay scheme.

According to proxy voting experts Manifest, the vote on the pay policy of the Edinburgh-based bank was the lowest level of support ever registered since a “say on pay” was given to shareholders in 2002-03. The vote in favour was just 8.4% – when deliberate abstentions are included. UK Financial Investments, the body which looks after the stakes in the bailed-out banks, voted against the report to protest about the £16.9m pension pot for the disgraced former RBS chief executive, Sir Fred Goodwin.

Shareholders had started the year in no mood to tolerate deviations from pay policies. In January 2009, the tone was set when the remuneration report of the housebuilder Bellway was voted down because directors’ bonuses had been paid even though their targets had not been meet.

Larger companies were also caught up in the wave of protests. The oil company Royal Dutch Shell suffered a shareholder revolt in a furious reaction to share awards to directors, which eventually saw the resignation of the head of the company’s remuneration committee. Investors voted against pay at the specialist lender Provident Financial. At the end of the year, shareholders were continuing to keep up the pressure when the remuneration report at Punch Taverns was cast aside because of the size of share awards and bonuses handed to directors despite £400m losses.

The first ever revolt against a remuneration report took place in 2003 when investors threw out the pay plans of the pharmaceutical company GlaxoSmithKline. According to Manifest, five remuneration reports were voted against in 2009 in the FTSE All-Share, more than any other year and beating the four that failed to make the grade in 2005. The “no” votes and deliberate abstentions are not enough, however, to force companies to claim back money paid to directors as the votes are only advisory


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