The new capital gains tax exemption for “Employee Shareholder” equity
Equity incentives are a key part of the remuneration arrangements for executives and other senior employees of insurance businesses, whether they be large insurers or brokers/other intermediaries. These take many and varied forms, from approved share schemes to bespoke arrangements for privately funded boutique brokerages. Such arrangements have the potential to incentivise performance, particularly long-term performance, and they often attract favourable tax treatment.
Typically, the principal tax objectives of any equity incentive arrangement are to ensure that there is no upfront income tax/national insurance charge on the grant of the equity, and to secure capital gains treatment on any subsequent sale of the shares. If the equity qualifies for entrepreneurs’ relief, so much the better as this allows certain individuals whose equity stake is at least 5 per cent to pay capital gains tax (CGT) at the rate of 10 per cent, rather than at the standard rates of up to 28 per cent.
The new CGT exemption, for “Employee Shareholder” shares
There is increasing interest in another CGT relief, which came into force on 1 September 2013, either as part of a stand-alone arrangement for individuals who would otherwise pay the 28 per cent rate of CGT or as part of a ‘package’ (including entrepreneurs’ relief) for managers with larger equity stakes. This is the ‘Employee Shareholder’ exemption which George Osborne announced last year, and which was included in the current Finance Act.
The key feature of this relief is that one or more employees give up certain (but not all) of their statutory employment rights in return for at least £2,000 of ‘free’ shares in their employer. The employee is not allowed to pay anything for the shares, other than giving up these employment rights. Although this exemption received a mixed reception in the press, it can be appropriate in certain situations particularly as:
- it provides a complete exemption from CGT when the shares are disposed of, rather than a lower rate of tax;
- up to £50,000 of shares can qualify for this exemption. As this is determined when the shares are issued to the employee, the exemption can be particularly valuable for shares whose value appreciates significantly (for example, where the shares are issued in a start-up situation);
- shares which qualify for this exemption can be given to existing managers. Contrary to popular belief, this relief is not just for ‘new hires’; and
- only certain statutory employment rights have to be given up, and it may be that the terms of the individual’s contract of employment are such that this is not a significant disadvantage.
Conditions and implementation
Inevitably, there are some conditions to be satisfied and the proverbial ‘traps for the unwary’ to be avoided when implementing such an arrangement. In this respect, two points are particularly noteworthy:
- If more than £2,000 of shares are given to the employee, there will be some income tax/ national insurance contributions to pay (on the value of the shares, over the £2,000 income tax-free amount). As the CGT exemption is for the first £50,000 of shares given to the employee there is an incentive to issue up to £50,000 worth of shares to each employee and, consequently, to incur such income tax/national insurance contributions, particularly if the shares are expected to appreciate significantly in value (as might be the case in relation to a company in the start-up phase of its development). This does run counter to much current tax planning, which (as noted above) often has the objective of ensuring that there is no upfront income tax/national insurance charge on the grant of the equity, but it is the cost of maximising the benefit of the CGT exemption. It is important to bear in mind that if the company is not successful, the fact that the shares have fallen in value will not result in these taxes then being repaid by HM Revenue and Customs.
- The relief is not available for anyone with a ‘material’ (i.e. more than 25 per cent) interest in the company at any point in the 12 months leading up to the acquisition of the shares. For larger companies, this may not be a significant impediment. For smaller companies, it means that careful thought needs to be given to the order in which shareholders invest. For example, in a start-up it might be necessary to ensure that those managers wishing to qualify for this relief do not do so until after certain other shareholders have invested (this runs counter to the traditional preference for the management team to form a new company, with the investors coming in at a later stage).
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PRA consultations signal tougher environment for run-off
The Prudential Regulation Authority (PRA) has published two consultation papers which will be of considerable interest to the London run-off sector, and of no little concern. The consultations, published earlier this month, invite comments on the PRA’s proposals in relation to the availability of solvent schemes of arrangement as a run-off exit solution, and regarding the ability of firms to extract capital in the course of a run-off.
Regarding solvent schemes, the PRA’s proposes that where a scheme is contemplated, the regulator will expect the firm to provide it with details of the scheme before any application to the Court is made. The PRA envisages that it will “in all cases” inform the Court whether it has any objection to the proposed scheme. Perhaps more ominously for the future availability of solvent schemes as an effective runoff exit solution, the paper indicates that “for insurance firms which meet regulatory capital requirements, the PRA’s starting point will be that the use of a scheme is unlikely to be compatible with its statutory objectives”.
Just as the PRA seems sceptical that a solvent scheme can be in the interests of the firm in question’s policyholders, so it perceives that “capital extractions through the life of a run-off inevitably weaken the level of protection available for remaining policyholders”. Among its proposals, the PRA states it will expect the applicant firm to have performed an up-to-date Individual Capital Assessment, which also takes into account the expected future run-off of the business. As part of the suggested new procedure, the regulator will also reserve the right to require the firm to commission an independent review of the analysis undertaken.
The deadline for comments on both consultation papers is 26 October 2013. While a strong reaction from the run-off community is expected, it remains to be seen whether the PRA will moderate its proposals.
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Financial Markets Amendment Act 2015
On 14 September 2013, the consultation document for the Dutch Financial Markets Amendment Act 2015 (the Amendment Act) was published. The Amendment Act is currently pending in the Dutch Lower House, but it is intended that it will enter into force on 1 January 2015.
The Amendment Act contains a number of changes to Dutch regulatory legislation, amongst others the modernisation of the right to collect premium payments by insurance intermediaries and the funding of the supervision of the financial sector. A more important change, however, is the extension of the scope of suitability and integrity testing.
Extension of the scope of suitability and integrity testing
The suitability and integrity requirements contained in the Dutch Act on Financial Supervision currently only apply to inter alia the managing directors and supervisory directors (known as (co-)policymakers and internal supervisors) of a licensed financial undertaking. The relevant regulator, the Netherlands Authority for the Financial Markets (AFM) or the Dutch Central Bank (DNB), determines whether such persons employed by a financial undertaking meet the suitability and integrity requirements. ‘Suitable’ means that the persons concerned have sufficient knowledge, skills and professional conduct for the tasks they perform. ‘Integrity’ means that the persons concerned have not committed criminal, financial, fiscal, administrative or regulatory offences.
As a result of the Amendment Act, other persons working at a bank or an insurer will also be subject to the suitability and integrity testing performed by DNB. This concerns persons working at a bank or insurer who are responsible for transactions which involve (large) financial risks, and, consequently, are in a position to affect substantially the risk-profile of the bank or insurer in question. Not all persons involved in the execution of such transactions will meet these criteria, but only the limited category of persons who are (in the end) responsible for the execution of such transactions, for example a head of the department of asset management.
Another consequence of the Amendment Act is that the obligation to take an oath or make a promise will be extended to the aforementioned persons, but also to other employees of financial undertakings whose activities directly relate to offering financial services.
In terms of integrity, it should be noted that in deviation from the integrity testing of (co-)policymakers and internal supervisors, which is performed by DNB, the explanatory notes to the consultation document provide that the bank or insurer will, primarily, be responsible for performing integrity tests. Furthermore, the DNB will not perform a full suitability test before such a person may be appointed. DNB will perform risk-based supervision and may incidentally conduct a minimal suitability and integrity test, for example by checking whether the right training certificates are in place and/or conducting a limited criminal investigation.
In extending the scope of the suitability and integrity testing to include directors at a bank or insurer, the Dutch legislator hopes to prevent risks that may further endanger the stability of the financial services sector.
Remuneration of authorised agents
As part of the Dutch Ministry of Finance’s objective for the financial services sector to give client-centred advice, the Dutch legislator has introduced a number of measures to remove the remuneration incentives that apply to advisers, intermediaries and authorised agents in respect of certain financial products.
From 1 January 2012, an ‘open norm’ was introduced which provides that insurers and (sub-)authorised (insurance) agents are not permitted to receive any commission, either directly or indirectly, which is not necessary for the provision of the financial service. This rule does not apply in a case where providing or receiving commission would not prejudice the obligation of the insurer and authorised agent to act in the best interests of its clients.
It follows from the explanatory notes that an authorised agent may be ‘appropriately’ rewarded in ‘reasonable’ proportion to the services it provides. What this means exactly has not been clarified, but the Dutch Minister of Finance has prohibited remuneration structures that incentivise insurers and/or authorised agents not to comply with their duty of care towards clients. As such, the Dutch Minister of Finance has stated that profit share related remunerations, bonus schemes and commissions based on sales (commissions associated with obtaining a certain turnover or production) are not permitted.
Furthermore, the AFM has issued its interpretation of this ‘open norm’. The AFM states that there should be a balanced relationship between the level of remuneration and the services provided (and related costs) by the authorised agent to eliminate any disincentive. According to the AFM, commissions based on production or sales/turnover are no longer permitted, nor is profit related remuneration. The AFM states that commissions based on a percentage of the premium are only permissible if very strict safeguards are in place to ensure the appropriateness of the remuneration.
Despite these developments, there is currently still considerable uncertainty as to what commission structures are allowed in the Netherlands, largely due to the open nature of the norm regulating the remuneration of authorised agents. Furthermore, recent research has shown that a large number of authorised agents and insurers have not yet reached agreement on a new remuneration model.
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Will new regulations ease restrictions on foreigninvested insurers opening branches?
On 15 March 2013, CIRC issued the Administrative Measures for the Market Access of Branch Offices of Insurance Companies, which took effect on 1 April 2013.
The Measures stipulate some new requirements for insurers opening multiple branches. For example, an insurance firm with existing registered capital of RMB 200 million needs to increase its registered capital by no less than RMB 20 million for each provincial branch office to be opened outside of its registered province. Firms with registered capital above RMB 500 million, however, are not required to increase their registered capital when opening a new branch office outside of their registered province.
Although not restricted by regulation, in practice a foreign-invested insurance firm will only be approved by CIRC to open one branch in each application. This implied restriction largely hinders the expansion of a foreign-invested firm in China. The Measures have been interpreted within the market as a signal that CIRC is likely to approve the opening of multiple branches by foreign-invested firms in a single application, but this remains to be tested in practice.
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New Code of Conduct for the distribution of insurance products
German Insurance Association (GDV) has issued the 2013 Code of Conduct for insurance distribution (the Code), with insurance firms able to adopt the new code since 1 July 2013. The purpose of the Code, first introduced in 2010, is to ensure consistent, high quality distribution of insurance products. Insurance firms will now need to decide whether or not they intend to adopt the more stringent 2013 Code.
The Code is binding on those firms that adopt it and consists of ten guidelines, as well as some additional requirements. Firms that adopt the Code must satisfy a new requirement that their compliance with the Code is certified by an accounting firm or a certified accountant. An implementation report will have to be submitted to GDV, initially after a full business year and thereafter every two years. The report can be based on the implementation of the provisions of the Code into the firm’s own governance and may, in addition, be based on the effectiveness of implementation.
The names of the insurance firms that have adopted the Code will be published on the GDV website. Firms subject to the Code will agree to work only with insurance mediators who recognise the principles in the Code as minimum standards and practice accordingly.
In addition, the 2013 Code introduces a new compliance provision. By adopting the new Code, insurance firms undertake to provide their employees and insurance intermediaries with compliance provisions relating to, among other things, gifts and hospitality. Finally, the Code reiterates that the customer is “at the centre” of the consultation and mediation of insurance products and emphasises the importance of ongoing training of insurance intermediaries.
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The outsourcing directive, Directive 159.A.i for both long-term and shortterm insurers, came into force on 12 April 2012. Outsource services are any aspect of a firm’s insurance business, supervised under any law or not, which is a function or activity which would otherwise be performed by the insurer itself, but not intermediary services.
Outsourcing must be given to someone competent to do it, must not adversely affect policyholders or materially increase the risk of the insurers, and must be overseen by the insurer. Suboutsourcing is possible.
The remuneration must be reasonable and commensurate with the actual function or activity outsourced, must not duplicate commission or binder fees, must not be structured so that the risk of unfair treatment of policyholders is increased, and must not be linked to the monetary value of claims rejected.
The insurer must have an outsourcing policy approved by its board of directors. Outsourcing must be in a written contract with at least the 20 requirements set out in the Directive. If control, management or material functions are outsourced, the Registrar has to be notified.
Outsourcing contracts were to be in place by no later than 1 January 2013.
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