Proposed US tax changes impact on US and Australian executive pay

The US is a global outlier on executive pay, driven in part (some would say mostly) by tax drivers enacted late last century.

The US “Tax Cuts and Jobs Act” (see HERE) proposes sweeping changes to the taxation of executive compensation and employee benefits, including equity awards.  This will be important to Australian companies with US executives, and has implications for most global companies given the predilection of the US to hoover up the best global talent because of its pay practices.

The key proposed changes affecting equity-based compensation are below.

  • Stock Options/SARs Taxed at Vesting.  The bill seeks to impose income tax once options or stock appreciation rights (SARs) are no longer subject to a substantial risk of forfeiture. This means stock options and SARs would be taxed at vesting, rather than at exercise. The bill does not address how the taxable income at vesting will be calculated. All we can say is that be prepared to entertain your US friends with the debacle of pre-July 1, 2015 Australian tax rules resulting in the taxation of underwater options.  Here, it led to the virtual elimination of options over-night. Imagine – US executive compensation without stock options!
  • Impact on RSUs.  Time-vested restricted stock units (RSUs) that are paid out when the employee meets the time-vesting conditions will continue to be taxed at vesting.  We expect that these will still be erroneously labelled LTIs.
  • Impact on PSUs.  Taxation of performance-based RSUs will occur when the employee meets the time-vesting conditions (if any).  In other words, a performance-based condition would not suffice to delay taxation beyond the end of any time-based vesting period.  If PSUs are not subject to time-vesting conditions, they will be taxed at grant.  This will kill innovative incentives associated with rapid milestone completion that pay out as soon as a milestone is reached, not at a particular time.
  • Impact on tax deductibility for high pay. Section 162(m) limits the amount of compensation paid to the CEO, the CFO and the three other most highly paid officers of companies with listing on US exchanges that can be deducted by the company to US$1 million annually, subject to exemptions for performance-based compensation which includes PSUs and stock options.  The bill proposes to repeal the exemption for performance-based compensation.  Consequently, PSUs and stock options will no longer be deductible to the extent that the employee’s compensation exceeds US$1 million. This has major implications. Firstly, Australian and other foreign companies with US executives will be in a much better position to compete for talent, given the after-tax compensation cost will be less than their US competitors. Secondly, Americans may ask themselves why bother paying incentives. After all, this is the major part of their taxation that drove US companies to scale-up performance based pay in the first place.

Outside of the US, US companies with global employee populations will need to consider whether it makes sense to make changes only for the U.S. population or for everyone, which could require a review of the non-U.S. tax and compliance issues for any new type of award.

While the final version of the Bill will probably have many changes, we can hardly wait. It was the unintended consequences of US tax anomalies that led to the incredible escalation in executive pay in the late 80s and 90s of last century. That these may change will no doubt have further unintended consequences that will impact not only US practice.

Amazingly, for all the massive tax changes being sought, it aims to be effective from 1 January 2018.  We will keep you posted.


© Guerdon Associates 2024
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