U.S. tax reform could present a dilemma for U.K. remuneration committees as we head into the 2019 annual general meeting (AGM) season. The headline change is that the U.S. corporate tax rate will decline from an upper limit of 35% to a flat 21%. Beyond this there are favourable changes to taxes on assets held outside the U.S. and a limitation of deductibility of certain compensation and benefit-related expenses. In the long term, most companies will see a net benefit to their after-tax earnings, although many will take a one-time hit to earnings on their FY 2017 financial statements.
For U.K. companies with U.S. taxable entities, there could be a potentially significant and unexpected post-tax advantage to the company and shareholders. As the bill became law in 2017, companies are already required to take consider potential tax liabilities and future financial benefits. The inverse impact may be the case for those in certain industries depending on their assets outside the U.S. and their current effective tax rate.
U.K incentive plans place a strong emphasis on financial performance, often assessed through P&L and/or balance sheet metrics. As an example of a post-tax metric, around 60% of FTSE 100 companies use earnings per share (EPS) in either their short-term or long-term incentive plans. The changes are expected to deliver an immediate bottom line impact for many going forward.
We anticipate that shareholders and proxy advisors will carefully scrutinise remuneration committees’ responses to these changes, in relation to both 2017 incentive outcomes and 2018 goal setting. When it comes to outcomes, generally speaking, there are two schools of thought:
- Tax and accounting legislative changes are something outside the control of management. This would lead committees to explore adjustments to reflect the impact of tax reform.
- The senior executive team plays a critical role in managing the effective tax rate. If the company and shareholders benefit from active management decisions, it may be appropriate to account for the law’s impact.
As companies with a December year-end finalize outcomes under their incentive plans for 2017, HR and Finance should be working together to understand the impact of these changes on outcomes, and the adjustments that would be required to net this out. Of course, it is also important to check that the power to make these adjustments is accommodated for within the remuneration policy. Remuneration committees should then review their established precedents, understand the impact, determine whether any adjustments should be made and agree how that decision will be disclosed in the remuneration report.
Looking beyond the immediate presenting issue, it will also be critically important for companies to assess the impact of U.S. tax reform on their strategies and operations, and what that may mean for the selection of incentive metrics and range setting going forward. For our perspective on how companies can select the most relevant performance measures and appropriately calibrate targets, see our article Is your target setting process hitting the mark?.
Heather Marshall is a director in Willis Towers Watson’s executive compensation practice in New York, having previously worked in London for over ten years. Alex Little is a senior consultant in Willis Towers Watson’s executive compensation practice in London.