24 December 2009
Alan Ewins – Partner, China and Hong Kong
Julia Gorham – Registered Foreign Lawyer, E&W, China and Hong Kong
The UK government last week announced a 50% windfall tax to be paid by banks on all bonuses over GBP25,000 which they award to bankers in the UK between 9 December 2009 and 5 April 2010.
The move, which will apply to all banks, including UK branches of foreign banks where bankers reside or perform services in the UK, has led to suggestions that there will be an exodus of top talent in the banking world to more tax-friendly financial centres including Hong Kong and Singapore.
Who is caught?
The tax applies to a number of categories of banks, building societies and other financial traders carrying on certain regulated activities and targets bonuses paid to their employees who perform certain specified duties “wholly or mainly in the UK” during this tax year.
The UK taxation authorities have confirmed that it is intended to bring back-office and support staff within the charge to the extent that their support duties, wholly or mainly, relate to the relevant regulated activity. There is still some uncertainty as to whether hedge funds, private equity and asset management companies are caught and further guidance is expected on these categories in due course.
This raises potential issues for Asian financial institutions with operations and bankers based in the UK. It also raises issues for many expatriates based in Asia and who perform services on a dual or split basis for two or more group companies, a part of which is in respect of UK duties. The tax catches duties performed for more than one company in the group (i.e. on a dual/split basis) but the draft legislation is not clear on how such split employments should be dealt with.
Banks may need to be prepared to assess the split in contribution between Asian and UK services and the level of any bonus award relative to each employment or the split in services. This may pose particular issues for those institutions who may have senior management functional leads located in jurisdictions other than the UK but whose oversight of UK operations may potentially bring all or part of their awards in scope for this tax.
What is caught?
As currently drafted, the legislation catches all “bonuses” which are “awarded” to a banker and which are over GBP25,000 (in aggregate) between 9 December 2009 and 5 April 2010 in respect of an employment which “wholly or mainly involves duties that relate either directly or indirectly to certain activities that are ‘Relevant Regulated Activities” (i.e. regulated by the UK’s Financial Services Authority). A tax of 50% will be payable by the employer on all amounts awarded in excess of the GBP25,000.
The definition of when a “bonus” or other “benefit” is “awarded” is complicated and the UK’s taxation authorities have released detailed guidance but in essence the question here is whether a contractual obligation to pay the bonus has arisen. It also catches bonuses, loans and awards for future payment – such that conditions for payment and deferrals are treated as not applying provided that the amounts are quantifiable. This will include deferred restricted stock awarded between now and 5 April 2010.
It is important to note the legislation is still in draft form and may therefore be subject to change. Given the many uncertainties in the current draft, professional and industry bodies are seeking clarification on the scope and application of the tax in a number of key areas. The UK government has, however, said the scheme may be extended further next year, for example to catch certain banks which have bonus award dates falling after April 2010.
What is not caught?
■Regular salary, wages benefits;
■Contractual bonuses (see below);
■Redundancy payments will not normally be caught but a termination payment or discretionary terminal bonus will be in scope; and
■Shares or share options awarded under an approved share incentive plan although other employment-related securities may still be caught.
There is an exception for contractual bonus entitlements where the bank has no discretion as to the amount of bonus because of a contractual obligation existing at the time of the announcement (9 December 2009). Where banks have contractually offered staff a sign-on bonus or some other form of guaranteed bonus, such awards should not be caught by the tax.
This does seem to be an inconsistent position by the UK government at a time when regulators worldwide, including specifically the HKMA, are calling for reduction in the use of contractual guarantees. It suggests that banks may be forced to continue to use contractual mechanisms such as generous sign-on bonuses to recruit and retain top talent if this scheme is extended further into 2010, flying in the face of the market’s move to use them only in exceptional circumstances.
The banks are required to keep records of all bonuses over GBP25,000 awarded in this period and report these even if they do not believe a tax change is due. The banks must also retain documents and evidence to support whether or not they fall within the payroll tax.
The move has been widely criticised by bankers who feel that the hit will be pushed down to employees in vast reductions in pay for the next financial year and many in the UK fear that their top talent will look for jobs elsewhere increasing the exodus of bankers to more tax-friendly jurisdictions. A number of financial firms have already announced plans to offer staff to relocate out of the UK in order to avoid this or future taxes.
This has led to significant speculation about the impact of this windfall tax (especially when coupled with the increase in the top band of tax to 50% from April 2010) on the UK’s competitive advantage as an international financial services centre. The French government has also announced that it is considering a similar proposal.
Some who comment on regulating banking pay see this move as a dramatic reaction and a move away from regulation towards what is essentially a penalty system. At the same time, there is an acknowledgement from key players in the financial services sector that bonuses must be reasonable and that banks and bankers should not profit from government bail-outs that have been provided over the last year and which may have boosted profits.
Further and more detailed updates on this topic will be circulated in due course. Please contact us if you require further details.
How can we help?
Allen & Overy Hong Kong has an integrated employment and regulatory team to assist with the employment and regulatory legal issues arising out of remuneration reform proposals. We work on an integrated basis with our global employment practice to assist in relation to arrangements in Europe and the US and, in Asia, we also have offices in the Peoples Republic of China (Beijing and Shanghai), Singapore, Bangkok and Tokyo.