Federal Government slammed over response to executive pay inquiry

Tax experts have criticised the Government’s response to the Productivity Commission’s report on executive pay, saying its rejection of a proposal that would defer taxation on employee shares, rights and options when executives leave a company is disappointing and poor governance.

The criticism comes as the Government suggests it will either support the remaining 16 proposals either fully or in principle, while adding some of its own recommendations, including a proposal to claw back bonuses paid to executives in the event of a misstatement.

Financial services minister Chris Bowen announced the Government’s response late last week, saying it would take on several of the recommendations including a “two strikes” proposal, which will establish consequences where businesses do not respond to shareholders recommendations on executive pay.

“Legislation giving effect to the reforms will be introduced this year, following public consultation on an exposure draft. The Government will also undertake consultation on the proposal to clawback bonuses paid to directors and executives in the event of a material misstatement of a company’s financial statements,” he said in a statement.

Bowen said legislation containing “many” of the PC’s proposals will be put forward in Parliament later this year. However, not everyone is happy with the Government’s intentions, with several business groups criticising one exclusion from the response.

The exclusion relates to a current law that forces executives to pay tax on company-provided shares, rights and options when they leave the business, resulting in a tax bill before the shares actually vest and any benefit is gained.

The Productivity Commission wanted the law to be a changed such that executives who leave a company could defer paying tax on the shares, rights and options.

Tax counsel at the Institute of Chartered Accountants in Australia, Yasser El-Ansary, says this encourages executives to dispose of these options well before they would be expected to otherwise. He argues this results in shareholders having a short-term view of business growth.

“I think, overall, people were fairly happy with the Government’s response and unfortunately they have not adopted this recommendation, which is an unfortunate result because it really is an important point.”

“This is a bad outcome, because executives should be encouraged to hold onto those shares even after they hold employment. It ensures that after their tenure they structure their behaviour around the long-term growth of the business.”

However, the Government argues introducing such a reform would cost the Government up to $310 million per year, saying the current rule has been in place since 1995 and doesn’t need changing.

“Removing this would increase the concessionality of schemes, providing a disproportionately large benefit to higher-income employees,” Bowen said. “It would reduce the integrity of the tax system, make it more difficult for the Australian Tax Office to ensure the correct amount of tax was paid and would have a significant cost to Australian Government revenue.”

But El-Ansary disputes that response. He claims the proposal doesn’t represent as much of an integrity risk as the Government believes it does, and “nor do I think it has that significant a cost attached to it”.

“I think over the next few months, and years, we should have a look at the Government’s assumptions and determine whether those are correct. I think there have been some very encouraging comments made by the Government on the issue, all very sensible, but it would be wise to revisit this issue.”

PricewaterhouseCoopers partner Debra Eckersley, Regnan managing director Erik Mather and KPMG equity compensation partner Martin Morrow have also criticised the Government for not including the recommendation. The Australian Institute of Company Directors has also criticised the Government’s response in full, saying it will add unnecessary regulation.

Other recommendations to be introduced into legislation later this year include requiring proxy holders to cast all their direct proxies on remuneration reports, prohibiting management personnel from voting on their own remuneration arrangements and establishing a review within five years to consider the effectiveness and efficiency of any reforms made.

The Government will also introduce the two-strikes proposal, whereby a company board will face re-election if more than 25% of shareholders vote against a remuneration proposal in two consecutive votes.

“This proposal is aimed at ensuring that, to the extent that pay packets are inflated by incorrect information, that money is returned to shareholders. A discussion paper will be released in coming months,” Bowen said.