EBTs, designed to safeguard deferred bonuses for the benefit of employees, have come under fire in recent years for being linked to tax avoidance. This article looks at the benefits of these vehicles.

After a recent appeal case, as covered by Executive Compensation Briefing, a sister publication to this news service, some have questioned whether employee benefit trusts, a UK structure that has seen tax advantages squeezed in recent years, have a future in the highly-regulated world of executive remuneration. Tania Bearryman, group director, Elian Corporate Services, takes a closer look at the issues.

The Guardian, 23 June 2015: "Top City bankers must wait 10 years for guaranteed bonuses, watchdogs rule"

Reuters Business News, 23 June 2015: "Britain finalises "toughest" banker bonus rules in the world"

Fund Strategy News Analysis, 14 September 2015: "Asset managers set for EU pay shake-up"

The Daily Telegraph, 12 November 2015: "British banks ordered to stop dodging bonus cap"

Efinancecareers.com, 8 January 2016: "Horror of the new UK bonus rules"

Controversy and intrigue surrounding senior executives' pay and bonuses is constant and seemingly here to stay.

The crisis of 2008 has led to significant changes to the way in which senior executives are paid, the make-up of that pay between fixed and variable elements and, in some cases, the period over which bonuses can be paid or deferred and clawed back or forfeited through various trigger mechanisms. In short, managing executive pay has become operationally complex, technically challenging and filled with regulatory and legislative pitfalls.

It is not only the banks that are being held to task on executive pay. Listed companies and asset managers of all types are also in the public eye. 

The guidelines: a summary

Banks: The Committee of European Banking Supervisors' Guidelines on Remuneration Policies and Practices currently in force will be replaced by the European Banking Authority's Guidelines on Sound Remuneration Policies published on 21 December 2015. The EBA's guidelines will become effective on 1 January 2017 and will seek to standardise the diversity of national rules currently in place across the EU. The EBA's guidelines are mandated under Directive 2013/36/EU (CRD IV).

Asset managers: The European Securities and Markets Authority's Guidelines on Sound Remuneration Policies (as mandated under Directive 2014/91/EU (UCITS V) and Directive 2011/61/EU (AIFMD)) were closed for consultation in October 2015 and are due to become effective on 18 March 2016, the date on which UCITS V also comes into effect.

Listed companies: On 11 November 2015 the Investment Association published its updated Principles of Remuneration providing guidelines for all listed UK plcs. Red and amber top ratings are prescribed where companies do not meet certain transparency conditions.

The stakeholders
Despite the varying risks posed by banks, asset managers and listed companies across the full spectrum of economic sectors, the requirements for transparency, deferral of bonuses, pay for performance and bonuses delivered in the form of shares or other financial instruments that mirror shareholder and investor risk are similar across all mandated and recommended remuneration guidelines.

There has been criticism of the Investment Association's stance on regulation of asset managers in recent months, with member firms coming down in both camps either supporting the Investment Association's views or threatening to withdraw membership. This has further fuelled the debate around regulation versus best practice and what the market (being investors and shareholders) want to see delivered. 

Listed companies that are not captured by the regulations affecting the financial services industry are not immune to the pressures of senior executive pay. Shareholder "revolts" around remuneration policies and re-election of board members have been avidly followed by the press and make for intriguing and inflammatory headlines.

The guidance issued by the Investment Association and its letter to remuneration committee chairmen includes an extension to post-vesting holding periods to facilitate claw-back of bonuses and limiting salary increases to inflation or that of the wider employee base rather than using industry benchmarking as a seemingly vague rationale for significant salary increases at senior levels. The Investment Association is also calling for greater transparency around bonus targets and the timeframe in which they will be disclosed. Bonuses in most FTSE 350 companies do meet the IA's vesting and holding period guidelines of at least five years.

The stakeholders are diverse when it comes to delivering an appropriate deferred bonus plan and each has a variation as to why they are interested.

The solution
The Office of Tax Simplification completed its review of unapproved employee share schemes in 2014 and concluded that there was no need to introduce a new "employee shareholder vehicle" following a consultation paper issued earlier that year. Offshore employee benefit trusts (EBTs) have been the vehicle of choice when implementing incentive plans designed to deliver share or financial instrument based bonuses over a deferral period.

EBTs have also been in the news in a very negative sense since the UK government cracked down on tax avoidance. As a result of the much-publicised Rangers case, the public has attached a very negative connotation to EBTs without being given the facts around their use and indeed their implied endorsement by the OTS through their recent consultation. Every vehicle, no matter how innocuous, can be used to meet the ends of tax evaders and those seeking to avoid taxes, albeit within the confines of the law as it stands. EBTs have born the brunt of the bad press. But their most frequent use is by companies to effectively implement bonus deferral plans into company shares, units in funds or other financial instruments to meet regulatory, stakeholders or legislative deferral requirements. 

With the advent of FATCA (introduced in 2014) and the Common Reporting Standard (coming into effect on a phased basis from 2016), which require reporting of financial accounts held across the world, a person's ability to get away without declaring income for tax purposes is greatly reduced. These regulations provide a transparent reporting framework that brings trusts back to centre stage for the original reasons that they were developed: to safeguard assets set aside by one party for the benefit of another.

The benefits
Share incentive plans and deferred bonus plans operated through EBTs using experienced trustees and administrators provide the following benefits to key stakeholders:
- operational effectiveness: by outsourcing the plan administration to professional trustees and administrators, the company is free to focus on its core business;
- project managing plan implementation: professional administrators often have specialist implementation teams who bring best practice and years of practical experience to the plan set up;
- strong governance: the value of company annual bonuses deferred can be quite substantial and it is important to entrust that value to a trustee and plan administrator that is subject to strong regulation and governance rules;
- accurate accounting records: all trust transactions are recorded and reconciled to company and third party custodial records on a regular basis by teams that specialise in trust accounting practices; 
- legal requirement to act in the best interests of plan participants: employees can take comfort in the fact that the trustee takes an unbiased, free of conflicts of interest view on all plan transactions, ensuring that their interests are protected by law, within the framework of the plan rules;
- online access to participant plan data: most trustees and plan administrators have invested significantly in developing online portals that deliver accurate, timely and relevant plan information to both participants and company plan coordinators;
- a single shareholder for all employee holdings: having a single shareholder on the share register aides transaction efficiency in managing voting rights, dividend payments, corporate actions and effecting good and bad leaver provisions;
- nominee facilities post-vesting: EBT trustees usually provide a nominee facility either to assist in post vesting retention periods or to manage holdings subject to forfeiture commonly used in private equity deals.

In conclusion
EBTs have been portrayed as tax avoidance schemes or worse for many years. The introduction of the “disguised remuneration” legislation in 2010 (Part 7A of ITEPA) and the General Anti-Abuse Rule in 2013 have ensured that going forwards EBTs are used in the way intended. 

EBTs are designed to safeguard deferred bonuses for the benefit of employees, while ensuring that malus and claw-back provisions are effective for those employees who do not meet the vesting or long-term governance requirements of their bonus deferral plans.