News › Taxand’s Take Article

Crisis, Clawback and Methodology

15 Mar 2011

As the first true global crisis of our time spans across countries, a colourful variety of recommendations, papers, codes and directives emerges in an attempt to address what has been pointed out as a key factor contributing to the current situation: "excessive risk taking" and its close relative in the compensation arena, "payment for failure".

One of the most controversial measures introduced is an array of norms (and quasi norms), the so called "clawback provisions". Dodd Frank Act, in the US, EC Recommendations of 30 April 2009, EU Directive CRD3 (2010/76), CEBS Guidelines or FSA Remuneration Code are some, to name a few, of the texts urging public companies worldwide, especially those in the financial sector, to implement provisions that allow them to clawback variable remuneration under certain circumstances.

Taxand's Global Compensation Service Line Leader examines why it is in this context that having an appropriate methodology can prove a valuable tool to save time and attain compliance with the best remuneration practices.

A clawback provision can be easily defined as an arrangement in which staff members agree to return ownership of an amount of remuneration to the company when the circumstances that prompted payment of performance based remuneration later prove wrong or inaccurate.

However, the confident officer (and, very likely, the Head of HR) first approaching these issues, may be unaware of the multiple problems that lurk round the corner.

A proper methodology should comprise, at least, analysis of the following areas:

Is the company in a position to identify the individuals to whom the clawback provisions should apply?

Pinning down the "risk takers" in a company requires an in depth organisational analysis affecting the highest ranking positions. It is a task that will probably demand the combination of the internal resources of the company as well as external ones, not least in an attempt to share the responsibility of putting the remuneration of board members and top executives at risk for the future.

Companies should also be aware of what is their decision taking model. A delegate model, widely spread in the financial sector, may mislead the well intended professional to identify many more risk takers than there really are.

Clawback provisions should tie in with the structure of the variable remuneration package, especially the upfront vs. deferred and the cash vs. shares split.

It is particularly relevant to identify opportunities where a "malus" adjustment can be implemented as an alternative to the proper clawback provisions. Said opportunities arise in connection to the deferred components. Indeed, "malus" will enable the company to adjust current or future non vested compensation instead of asking its executives return to the amounts paid in previous years.

Share based remuneration presents problems of its own. Defining if clawbacks should operate on a certain number of shares or, rather, on value, may depend on the type of scheme we are dealing with and the existence, or not, of restrictions to the transferability of the shares.

Finally, companies should define how far back the clawback provisions will reach and the circumstances in which they will operate (i.e. causes for restatement of financial reports).

Although clawback provisions are usually defined as a contractual arrangement, the truth is that governments and companies alike are being given a mandate to forcibly incorporate a new provision into compensation plans that may clash with the content of existing labour or compensation agreements.

A revision of the labor agreements in force is therefore required before implementing any clawback policy that will later work when needed.

The main tax question is whether the amounts clawbacked should be net or gross and what should the course of action be in respect to tax amounts already paid or withheld on remuneration that later proves "nonexistent".

Clawbacks may also put in danger certain common tax exemptions on share based payments.

All the above questions, especially those regarding tax and legal issues, multiply when dealing with different jurisdictions. It is not difficult to find developing countries that act as recipient of big numbers of expat executives where, simply put, clawback provisions, as required by the EU, US or other international organism codes, are not enforceable.

Companies should then develop alternative compensation strategies to avoid internal discrimination between their executive teams.

Last but not least, companies should be in a position to accurately describe their clawback policy in any remuneration report or filing due, to the extent required by the applicable law and the best governance practices.

Taxand's Take

The Remuneration Committe members, HR professionals and tax and legal professionals alike will be in need to cooperate and come up with a comprehensive methodology to analyse the necessity to introduce clawback provisions in their compensation policy, define their extent, and do so effectively. The main questions facing businesses are:
  • Identification and interpretation of applicable legal texts or corporate governance recommendations (US, EU, other regions)
  • Definition of employees to whom the clawback clause applies, how far back does it reach and when (including circumstances where a restatement of financial report will NOT trigger the clawback clause)
  • Compensation components subject to forfeiture risk and mechanics of the clawback
  • Legal support: potential conflict with existing labour arrangements
  • Tax issues
  • Identification of possible alternatives: "malus"

Indeed, a methodology that delves deeply into a variety of areas, from corporate governance to labour law and taxation and that requires bringing together both a generalist and a specialist perspective is needed. Multinationals should seek ways to maximise the coordination of this process to benefit.

Your Taxand contacts for further queries are:
Jaime Sol
T. +34 91 514 52 00

Gonzalo Fern?ndez
T. +34 91 514 52 00

More news from Taxand Spain:

We are interested to hear your opinion on this key piece of tax news. Join our LinkedIn Group and share your ideas. With tax professionals in nearly 50 countries you can understand the impact of tax issues affecting multinationals today.

Taxand's Take Author