* $SSHQGL[*²1HZVSDSHUUHSRUWV This selection contains reports from the press concerning employee share plans, their funding arrangements and tax consequences. A creative deal for BHP’s new boss 1 Michael Laurence The newly appointed chief executive of BHP, Paul Anderson, is seeking one of Australia's most creative and unusual remuneration deals. Unlike the arrangement for 95% of executive option schemes in this country, US-born Anderson wants to use a special-purpose trust to hold up to one million “performance rights”. Although BHP is not giving away much detail, Anderson's motives for using a trust, rather than holding the rights in his own name, are clear: if he meets performance and length-of-service hurdles, the trust structure will deliver considerable tax-deferral advantages for up to 10 years and, even before the shares are vested in his name, he will get a sizeable dividend flow. This is truly sophisticated tax planning, and illustrates the outstanding salary-packaging opportunities for executives who are prepared to think differently. The performance rights are in addition to options that are based on company performance, as measured against Australian and international benchmarks. Anderson has surprised colleagues with his determination to deal directly with professional advisers on the tax aspects of his package and with his determination to place much of his remuneration at risk by being performance-based. With one million performance rights and one million employee options, both dependent on performance, he is the first BHP boss to have any remuneration based on meeting 1 Business Review Weekly, 8 February, 1999. 260 SHARED ENDEAVOURS defined achievement goals. However, previous chief executives have held company-provided BHP shares. If shareholder approval for the performance rights and options is not gained later this month, BHP is obliged to provide Anderson with equal after-tax benefits in some other form. The mechanics of the special-purpose trust are fascinating. Whenever Anderson meets staged short and long-term performance benchmarks, the trust will acquire BHP shares. However, Anderson could choose not to exercise his performance rights for up to 10 years and thus defer tax on the accumulated value acquired by the trust during this period. Meanwhile, he receives all dividends. If he had taken the conventional course of immediately taking the rights in his own name, he would have had no access to the dividends before the rights were exercised. He receives the double benefit of tax deferral and a large income. Anderson will pay nothing for either the rights or, provided the performance goals are met, the shares themselves. An independent trust could protect Anderson if he satisfied the performance criteria yet became involved in a dispute with the company for any reason. The trustee would have to transfer shares into his name, regardless of a possible disagreement between Anderson and his employer. BHP can claim tax deductions for the cost of providing shares and, under a clause in the FBT Act, employee shares and options held in trust are not subject to fringe benefits tax, provided the securities are in the employer's company. Anderson's “performance rights” are options by another name. As an executive who was appointed after an international headhunt, the magnitude of Anderson's package is not surprising. The really big money for performing executives comes from shares and options, not from cash salary. If a company really performs, cash salary must seem like pocket money. Employee shares and options plans are coming up to harvest time 2 Michael Laurence Thousands of high-earning executives are about to participate in their seemingly crazy annual ritual of receiving hefty cash bonuses for top performance over the past financial year and immediately throwing half away in tax. Suddenly, a $100,000 bonus evaporates into $51,500 after tax. A smarter way to be rewarded for performance is through a combination of a cash bonus and tax-deferred shares/options in the employer's listed business. 2 Business Review Weekly, 22 June, 1998. APPENDIX G – NEWSPAPER REPORTS 261 Whereas cash bonuses are taxed in an executive's hand at 48.5%, personal tax is deferred on executive share and option plans - and the employer is not subject to fringe benefits tax (FBT). Kris Chikarovski, a director of the consultancy Remuneration Planning Corporation, suggests that executives whose employers do not have a share plan should begin lobbying now for the introduction of one by the end of next financial year. Shareholders must approve proposed share plans. “After shareholder approval, there is usually a lead time of two to three months before a plan is introduced,” he says. A study by Equity Strategies shows how popular executive share and option plans are becoming. The share-plan consultancy has examined the 1997 annual reports of 122 of Australia's 150 biggest public companies in a search for executive share/option plans. In that year those companies introduced, amended or renewed 52 executive option plans and 15 share plans, and 78% of these plans contain performance hurdles. Edward Wright, a director of Equity Strategies, says annual cash bonuses tend to reward executives for meeting short-term goals. Bonuses are often designed to encourage executives to reach individual or team targets. By contrast, shares and options tend to reward executives for meeting longer-term, company-wide hurdles such as gaining a certain return to shareholders. Share/option plans usually have performance targets of three to five years. Wright says: “A growing trend will be to take part (of an incentive) in cash and shares; both the tax and the reward are deferred. This means a longer-tail for annual bonuses with part paid in cash up front and part in shares that may be forfeited down the track if, say, a project does not meet expectations.” For example, an executive might receive a bonus for having an idea, then shares if that idea can be transferred into a money-making enterprise for the company. The better the company does in future years, the more valuable the shares become. Finding the right incentive What is the most appropriate performance incentive for a company to gain the optimum from executives? Wright says: “There is no off-the-shelf solution. Each company is unique. The circumstances of the company, the outlook for the industry and the goals of the plan should be carefully considered.” According to Equity Strategies research, more than seven performance hurdles are used in the executive plans that were introduced, modified or renewed during 1997. The main hurdles are a set increase in: total shareholder returns as measured by capital gains and dividends, the share price (by far the most prevalent hurdle), profit, earnings per share, and return on equity. Such companies as Westfield Holdings base their executive incentive plans on a special premium above a 262 SHARED ENDEAVOURS certain target. And a number of companies adopt a variety of hurdles, including personal ones and others set at the board's discretion. Wright says there is good reason companies often regard option plans as add-ons to share plans and other incentive schemes. “An executive option plan will lose its power to provide incentives if there is a drop in the share price below the exercise price. With shares, however, there should always be value.” There are crucial differences in the tax obligations of an executive who participates in a share/option plan with various performance triggers if targets are met, or in what could be termed salary-sacrifice arrangements involving shares and options: *Incentive share/option plans. No personal tax is payable in the year that the awards are promised. With shares, capital gains tax (CGT) usually becomes payable by the executive in the year that the actual stock is placed in the person's name. (With most incentive share schemes for executives, all - or a portion - of the shares are vested in the individual after three years provided performance hurdles are met.) With options, the executive generally does not pay CGT until the options are exercised some years after issue, even if the value of the underlying shares has increased markedly in the meantime. *Salary sacrifice share schemes. These typically vest in the employee each year. Straight salary or cash bonuses are frequently exchanged for extra contributions to such plans. An employee does not pay tax on the shares - apart from income tax on annual dividends - until the sale of the stock, termination of employment or until 10 years after acquisition. At the point of taxation, CGT becomes payable on the full value of the shares. Chikarovski of Remuneration Planning Corporation says the main attributes of share plans from an executive's perspective, rather than an employer's, are the tax deferral, the benefit of any increases in share prices, and the growth in dividends (in the case of salary-sacrifice schemes). Chikarovski says: “The amount of benefit from a share plan is not immediately diluted by tax.” So an executive is effectively gaining a leveraged position in the sharemarket because twice as many shares are acquired than could be bought if after-tax income were used. Chikarovski adds that executives benefit from any increases in share price. “Unlike cash, the shares endure as a reminder of past performances.” Share and option incentive schemes may be appropriate for listed companies, but what about private companies? The owners of unlisted companies are usually reluctant to give away any of their equity, even to top-performing employees. Wright of Equity Strategies says the answer for private companies can be so-called phantom share schemes. Phantom schemes create “units”, not actual shares, in a business. The units are based on a clearly defined method of valuing a private company, such as a APPENDIX G – NEWSPAPER REPORTS 263 multiple of its earnings.