Executive remuneration is a highly debated topic in Australia. Now, as much as ever, companies and executives need to remain aware of changes as they occur, as they will have structural implications for remuneration arrangements going forward.
The challenge for lawyers and other practitioners in this field is that it cuts across several areas of specialisation – tax, corporate and employment. This chapter is the combined work of a team of lawyers specialising in these areas who work together to provide corporate and individual clients with seamless advice that covers these speciality areas.
i Income tax for employees
Determining residence of an employee
Under Australian domestic law, Australian-resident taxpayers are assessed on their worldwide income. An employee would usually include employment income in their assessable income in the income year in which it is received in cash (rather than when the entitlement to receive the amount accrues to the employee).
Non-resident individuals are generally only assessed on income derived directly or indirectly from sources in Australia (subject to certain exemptions). In particular, non-residents may be liable for withholding tax on dividends, interest, certain managed investment fund payments and royalties from Australian entities. Non-residents may have relief from double taxation under a double tax agreement if they are a resident in a country with which Australia has formed such an agreement.
A person may be a resident of Australia under Australian domestic law if he or she satisfies either a common law test or one of three statutory tests.
Individual taxpayers will be considered residents under the common law test if they reside in Australia. The term resides takes on its ordinary meaning as 'to dwell permanently, or for a considerable time, to have one's settled or usual abode to live in a particular place'. Whether a taxpayer resides in Australia will be a question of fact to be determined on an annual basis. The Australian Commissioner of Taxation (Commissioner) has outlined some of the factors that should be taken into account in considering this question in Taxation Ruling 98/17, including:
- behavioural factors: including personal intentions or purpose of presence, family and business ties, maintenance and location of assets, place of abode, and social and living arrangements; and
- physical presence: where an individual displays behaviours consistent with them residing in Australia over a period of time (generally six months).
Where the common law test is not satisfied, each of the three statutory tests must be applied in the order set out below.
Under the domicile test, an individual whose domicile is in Australia will be a resident of Australia unless the Commissioner is satisfied that the person's permanent place of abode is outside Australia. An individual's domicile generally refers to that person's place of birth; however, this may change when a person moves indefinitely to another country. The question as to whether an individual's permanent place of abode is outside Australia is a question of fact, and includes considerations such as the intended and actual length of the individual's stay in a foreign country. Generally, a period of two or more years outside Australia would indicate a taxpayer's permanent place of abode is overseas.
Under the 183-day test, non-residents will be tax residents of Australia if they are physically present in Australia for more than 183 days during a year of income, either continuously or intermittently, unless the Commissioner is satisfied their usual place of abode is outside Australia and the individual does not intend to take up residence in Australia. The discussion above in relation to permanent place of abode is relevant to considering whether an individual's usual place of abode is outside Australia.
Finally, an individual may be a resident of Australia if he or she contributes to a superannuation fund for certain government officers.
Temporary residents who hold a temporary visa under the Migration Act 1958 (Cth) may be subject to different tax treatment to non-residents. Generally, foreign-sourced income (other than income related to employment) and capital gains derived by temporary residents would be treated as non-assessable and non-exempt income.
Income tax rates
The tax rates (known as marginal tax rates) for Australian residents for the income year ending 30 June 2021 are as follows:
|Taxable income||Tax on this income*|
|A$0 to A$18,200||Nil|
|A$18,201 to A$37,000||19 cents for each A$1 over A$18,200|
|A$37,001 to A$90,000||A$3,572 plus 32.5 cents for each A$1 over A$37,000|
|A$90,001 to A$180,000||A$20,797 plus 37 cents for each A$1 over A$90,000|
|A$180,001 and over||A$54,097 plus 45 cents for each A$1 over A$180,000|
* These rates do not include the Medicare levy of 2 per cent or the Medicare levy surcharge (between 1 and 1.5 per cent if a taxpayer does not have a prescribed level of private hospital insurance)
For non-residents, the marginal tax rates are currently as follows:
|Taxable income||Tax on this income*|
|A$0 to A$90,000||32.5 cents for each A$1†|
|A$90,001 to A$180,000||A$29,250 plus 37 cents for each A$1 over A$90,000|
|A$180,001 and over||A$62,550 plus 45 cents for each A$1 over A$180,000|
* Foreign residents are not required to pay the Medicare levy
† Where an individual taxpayer is resident for only part of an income year, the tax-free threshold must be apportioned based on the number of months the individual is considered a resident of Australia
The above tables include changes to the marginal tax rate thresholds announced by the federal government in the 2018–2019 and 2019–2020 budgets and implemented in legislation. The implemented measures will apply in their entirety from 1 July 2024, with gradual changes applying from 1 July 2018 as set out in the tables above.
From 1 July 2022, the top threshold at which the 19 per cent marginal rate will apply will increase from A$37,000 to A$45,000, and the top threshold at which the 32.5 per cent marginal rate will apply will increase from A$90,000 to A$120,000.
From 1 July 2024, the 32.5 per cent marginal rate will be reduced to 30 per cent, and the top threshold at which this marginal rate will apply will increase from A$120,000 to A$200,000.
The highest marginal rate of 45 per cent will apply to taxable income exceeding A$200,000. The 37 per cent bracket will be removed entirely.
On 23 July 2020, the federal government announced as part of an Economic and Fiscal Update that it is considering additional tax cuts for individuals as part of a recovery plan in the wake of the covid-19 pandemic. This is expected to be confirmed in the 2020–2021 Federal Budget to be delivered on 6 October 2020.
Income tax treatment for employees of employee share scheme interests
An employee will be subject to tax on any discount given in respect of shares or rights to acquire shares (including options or restricted stock units) when those interests are acquired. However, if shares or rights are provided under a complying employee share scheme (ESS), then an employee may defer the tax payable in respect of acquiring the shares or rights.
Alternatively, an ESS may be structured so that an employee may be eligible for an exemption for the first A$1,000 worth of shares or rights if certain conditions are satisfied, including that the employee's adjusted income is less than A$180,000.
Some smaller companies that meet certain requirements might be eligible to grant shares2 or options that are eligible for the start-up concession.
The following table shows the taxation of options, start-up concession options, restricted stock and restricted stock units. It has become popular to issue performance rights or similar interests in Australia, and these should be taxed in a similar manner to restricted stock units. However, as a result of changes made in 2015, it has become popular once again to issue options.
|Option||Start-up Options||Restricted stock||Restricted stock unit|
|Tax treatment upon grant?||No tax payable on grant, provided relevant conditions for deferral satisfied||No tax payable if the company and the options meet certain requirements||No tax payable on grant, provided relevant conditions for deferral satisfied||No tax payable on grant, provided relevant conditions for deferral satisfied|
|Tax treatment upon vesting?||For options granted between 1 July 2009 and 30 June 2015: tax on market value less cost (if any) at ESS deferred taxing point* (generally vesting unless genuine restrictions on exercise or disposal)||No tax upon vesting||Tax on market value of shares at ESS deferred taxing point‡ (generally vesting unless genuine restrictions on disposal)||Tax on market value of shares at ESS deferred taxing point‡ (generally vesting unless genuine restrictions on disposal)|
|Tax treatment upon exercise/delivery?||For options granted on or after 1 July 2015: tax on market value less cost at ESS deferred taxing point** (generally exercise* unless genuine restrictions on disposal of resulting shares)||No tax upon exercise||No tax, unless ESS deferred taxing point has not yet happened||No tax, unless ESS deferred taxing point has not yet happened|
|Tax treatment upon sale of underlying shares?||Further gain (in excess of market value at ESS deferred taxing point plus exercise price) would be subject to capital gains tax, unless sold within 30 days of ESS deferred taxing point. If shares acquired upon exercise of options held for at least 12 months prior to sale, a discount may be available on any capital gain||Gain on disposal of options or shares acquired upon exercise of options subject to capital gains tax. If options or shares acquired upon exercise of options are held for a combined period of at least 12 months prior to sale, a discount may be available on any capital gains||Further gain (in excess of market value at ESS deferred taxing point) subject to capital gains tax unless sold within 30 days of the ESS deferred taxing point. If shares held for at least 12 months after ESS deferred taxing point, a discount may be available on any capital gain||Further gain (in excess of market value at ESS deferred taxing point) subject to capital gains tax unless sold within 30 days of the ESS deferred taxing point. If shares held for at least 12 months after ESS deferred taxing point, a discount may be available on any capital gain|
* ESS deferred taxing point for rights (such as options or restricted stock units) granted between 1 July 2009 and 30 June 2015 is the earliest of:
** ESS deferred taxing point for rights (such as options or restricted stock units) granted on or after 1 July 2015 is the earliest of:
However, regardless of when the right was acquired if the resulting share is disposed of within 30 days of the ESS deferred taxing point, the ESS deferred taxing point will be moved to the date of disposal.
‡ ESS deferred taxing point for shares (such as restricted stock) is the earliest of:
ii Social taxes for employees (foreign service income)
Where a taxpayer is considered to be an Australian resident, foreign service income may be exempt from tax in Australia provided certain conditions are satisfied. Specifically, under Section 23AG of the Income Tax Assessment Act 1936 (Cth), the foreign earnings of an individual taxpayer who is engaged in certain types of foreign service for a continuous period of 91 days or more should be exempt from Australian tax. The categories of work that qualify for the exemption are very narrow: the exemption is generally limited to aid workers, charitable works and government employees. As of 1 July 2016, Australian government employees who earn foreign income while delivering Australian official development assistance have not been eligible for exemption from Australian income tax on their foreign employment income.
If an Australian resident's employment income is taxed in another country, the employee may be entitled to a foreign income tax offset in respect of the tax paid in that other country.
iii Tax deductibility for employers
Remuneration (including bonuses)
Generally, remuneration paid to employees will be deductible to an employer, provided the expenditure is incurred in gaining or producing assessable income and is not of a private or capital nature. Usually, a tax deduction is available in the year in which the employer incurs the liability to pay the salary or wages. However, in some circumstances, prepaid salary and wage expenses may not be deductible in the year the payment is incurred.
Expenses relating to annual leave, long-service leave, sick leave or other leave are only deductible when the relevant amount is actually paid to the individual to whom the leave relates.
Bonuses paid to an employee should be deductible when the expense is incurred. This generally requires that the bonus is capable of reasonable estimation and that a legal liability to pay the bonus has arisen.
Employers (including a foreign company that has employees who are liable for taxation in Australia) will need to register for and remit tax instalment deductions known as pay-as-you-go withholding tax in respect of the salary and wages of their employees.
Employers may also be required to pay payroll taxes to state authorities. Additionally, a superannuation guarantee charge may be payable to the Australian Taxation Office (ATO) if an employer does not make the minimum level of superannuation contributions (up to the maximum contribution base) for each employee (currently 9.5 per cent of employees' ordinary time earnings).
Fringe benefits tax may be payable by an employer on the value of certain fringe benefits (such as non-cash allowances, gratuities, compensation, benefits, bonuses and premiums) provided to employees (or associates of employees) in respect of the employment of the employee. Fringe benefits tax is a separate tax from income tax and is payable by the employer at a rate of 47 per cent.3 Where fringe benefits tax has been paid, the taxable value of the fringe benefit will generally be deductible to the employer. The value of the fringe benefit received is not assessable to the employee.
iv Other special rules
Special rules may apply where a business is sold, and the new employer takes on the existing long-service leave, annual leave, sick leave or other leave obligations of the former employer in respect of employees transferred to the new employer. The former employer would not be entitled to a deduction for that leave unless it makes an accrued leave transfer payment to the new employer because an Australian law, award or industrial agreement requires the former employer to make the payment. The new employer would include the accrued leave transfer payment in its assessable income, and claim a deduction for providing the leave when the employer pays an amount to the individual to whom the leave relates.
III TAX PLANNING AND OTHER CONSIDERATIONS
i Alienation of personal services income
Income from personal exertion is usually taxed as ordinary income of the taxpayer. It is generally very difficult to structure an employment relationship to achieve a different tax treatment.
Various structures may be employed to seek to achieve income splitting. For example:
- In the case of a taxpayer who carries on a business, it may be possible to equitably assign, for value, the interest in the business from which the income is derived. For example, in the Everett case,4 a partner in a partnership equitably assigned his interest in the partnership to another person. However, if an equitable assignment is not done effectively, the assignor will still be subject to tax in the full amount and will not be entitled to a deduction for payments to the purported assignee. Further, on 14 December 2017, the Australian Taxation Office (ATO) suspended its previous guidance (Assessing the Risk: Allocation of profits within professional firms guidelines and Everett assignment guidelines) in relation to Everett assignments because of concerns that taxpayers' arrangements were going beyond the original intent of the guidelines and other high-risk behaviour. Consultation with stakeholders on replacement guidance has been ongoing since early 2018 with a view to publishing new guidance. Taxpayers who entered into arrangements prior to 14 December 2017 may continue to rely on the suspended guidelines for the year ended 30 June 2020 provided that their arrangement complies with the suspended guidelines, is commercially driven, and does not exhibit high-risk factors.5 The ATO has also asked taxpayers contemplating entering into new arrangements, or who have concerns or uncertainty regarding potential high risk factors in their current arrangements, to engage with the ATO. It should also be noted that the Treasury Laws Amendment (2019 Tax Integrity and Other Measures No. 1) Bill 2019, which received Royal Assent on 28 October 2019, makes changes to the capital gains tax small business concession as it applies to Everett assignments of partnership interests with effect from 8 May 2018.
- Where a taxpayer provides personal services through a family trust or a corporation, the ATO would normally tax the individual providing the services, rather than the entity that has been engaged to procure the services of that individual. For example, if a taxpayer sought to arrange his or her affairs so that his or her salary was paid into a trust and then distributed to different family members, this may not be effective for tax purposes.
Similarly, there are statutory restrictions on the alienation of personal services income. In particular, Divisions 84 to 87 of the Income Tax Assessment Act 1997 (Cth) contain rules that effectively look through structures used by an individual who provides personal services through a vehicle. For example, if a taxpayer provides personal services through a company, the company would pay tax at marginal rates on that income (see Section II.i).
ii Foreign executives moving to Australia
Foreign executives moving to Australia will need to plan their move very carefully. As discussed in Section II.i, the Commissioner will treat an executive as a tax resident of Australia if the executive commences residing in Australia (unless treaty relief is available).
Double tax agreements provide a tiebreaker where two countries would treat an individual as a resident in their country. Australia has entered into double tax agreements with many of its main trading partners (notably, except Hong Kong, as well as various other jurisdictions).6 If the executive is treated as an Australian tax resident, he or she may be entitled to a foreign income tax offset for any tax paid in his or her home jurisdiction, subject to a cap.
A person who qualifies as a temporary resident in Australia7 is not taxed on his or her foreign-sourced income apart from personal services or employment income. A temporary resident is also not liable to capital gains tax unless an asset is taxable Australian property (broadly, a direct or indirect interest in land situated in Australia).
IV EMPLOYMENT LAW
i Non-competition covenants
Non-competition covenants are permitted and enforceable. However, there are some complexities.
The starting point is that post-employment restraints (whether in the nature of non-competition or non-solicitation covenants) are presumed to be invalid and unenforceable. This is because such restraints are considered to be contrary to public policy: the law does not like to see an individual prohibited from working in his or her lawful trade and generating an income.
The onus falls on employers to demonstrate that, on the basis of its particular circumstances, a restraint is reasonable (having regard to the interests of the employer, the employee and the public), and is no wider than is reasonably necessary to protect the employer's legitimate interests.
There is a large and constantly evolving body of case law that sheds light on when a post-employment restraint is reasonable. Courts will have regard to the nature and extent of the restraint, its geographical reach and its duration. Insofar as the nature of a restraint is concerned, Australian courts are far more reluctant to enforce non-competition covenants than non-solicitation covenants (as to which see below). Non-competition covenants are rarely enforced unless a former employer agrees to compensate his or her former employee for his or her inability to work during the restraint period. This usually involves the former employer paying the former employee a sum equivalent to the amount the former employee would have earned had he or she continued to be employed by the former employer during the relevant period.
Australian courts also retain a broad discretion to decline injunctive relief to enforce a restraint even if the former employer discharges the onus of proving that the restraint is reasonable. The existence and exercise of this discretion can make the task of enforcing post-employment restraints very difficult for employers.
Non-competition covenants can be enforced by both injunctive relief (temporary and permanent injunctions) and by orders for monetary compensation. Most non-competition covenants spell this out. Sometimes they go further and provide for liquidated damages.
Geographical or time limitations
Two of the factors a court will take into account when considering the reasonableness of a post-employment restraint are its geographical reach and duration. It is important that both go no further than is necessary to protect an employer's legitimate interests. For example, if an employee has only ever worked in Australia, it is unlikely a restraint operating outside Australia would be found to be reasonable.
As far as duration is concerned, the key question is usually how long does a former employer need to replace a departed employee and give that replacement a reasonable opportunity to establish relationships with the former employer's clients, thereby giving the former employer a reasonable opportunity to protect its business. Depending on the circumstances (such as the duties of the employee and the depth of his or her client relationships), this period might be somewhere between three and 12 months. It is rare for post-employment restraints to be upheld for longer periods.
Limitations on competition
Post-employment restraints can only be used to protect an employer's legitimate interests. This requires careful identification of the employer's business and its true competitors. If a restraint extends beyond these parameters, it is unlikely to be found to be reasonable.
Gardening leave provisions
In most cases, a court will take into account a period of gardening leave when assessing the reasonableness of a post-employment restraint. An employer is not likely to be able to extend the duration of a reasonable post-employment restraint by also providing for gardening leave prior to termination of the employment relationship.
If a former employee was the owner (or part-owner) of a business that was acquired by the former employer and the restraint was entered into to protect the former employer's investment in that business, a court will take a much more robust view about enforcing the restraint. This is because the character of the restraint is different. In this context, the restraint is part of a commercial arrangement, as opposed to a simple employment relationship. The commercial benefit derived by the former employee by virtue of the sale of the business to the former employer is a highly relevant factor taken into account in determining the reasonableness of a restraint.
ii Non-solicitation covenants
Enforceability against employees
Courts in Australia are more willing to enforce these types of restraints than pure non-compete restraints. This is because the enforcement of these more limited restraints does not usually deprive employees of the ability to work and earn an income. However, these restraints must still be reasonable and go no further than is necessary to protect former employers' interests. For example, a covenant will usually need to be limited to the non-solicitation of clients with whom a former employee had some dealings before he or she left his or her former employer's employment. A non-solicitation covenant that seeks to preclude solicitation of all the former employer's clients or customers, even those with whom the former employee had no dealings or knowledge, is unlikely to be found to be reasonable.
The position is the same as that set out above in relation to non-competition covenants.
Limitations on scope
As with non-compete covenants, non-solicitation covenants must also be limited in geographical reach and duration.
iii Repudiation of contract and post-employment restraints
Repudiation is 'conduct which evinces an unwillingness or an inability to render substantial performance of the contract'.8 Some examples of repudiation in the employment context include where an employer unilaterally reduces an employee's pay or significantly changes his or her responsibilities (e.g., a demotion) without the contractual power to do so. The test for repudiation is an objective one. In the event of a repudiation, the innocent party has the option to either affirm the contract or to accept the repudiation and treat the contract as having come to an end.
If accepted by an employee, an employer's repudiation of an employment contract invalidates post-termination restraints entirely. The principle that post-termination restraints do not survive an employer's repudiatory breach goes back more than 100 years to a UK House of Lords case.9 It has been followed and applied in the Australian High Court10 and most recently in the Victorian Court of Appeal.11
An employer should therefore take great care when terminating an employee's employment not to do anything that might amount to a repudiation of an employment contract or it may not be able to rely on any post-employment restraints.
iv Termination of executives
There are both contractual and statutory restrictions on an employer's ability to dismiss an executive.
A termination must be carried out in compliance with the requirements of an executive's employment contract. In Australia, most executive contracts provide for termination without cause by an employer simply giving an executive a specified amount of notice or making a payment in lieu of that notice. Notice periods vary from the statutory minimum (which ranges from one to five weeks, depending on the length of service and the age of the employee) to three, six or nine months, or, perhaps, up to 12 months.
Executive contracts also usually contain a provision for termination summarily (i.e., without notice) where an executive has committed an act of serious misconduct. Serious misconduct is not just unsatisfactory performance, but misbehaviour to such an extent that it can be said an executive has demonstrated that he or she is no longer willing to be bound by his or her employment contract.
Under contract law, an employer can dismiss for any reason and does not need to articulate that reason. However, this position has been modified by a number of different statutes at both the state and federal levels. For example, a termination implemented because an executive possesses an attribute protected by one of Australia's many anti-discrimination laws (which cover attributes such as gender, race, religion, sexual orientation, disability and age) would be unlawful. If a discrimination claim is made and upheld, a range of remedies are available to a former employee, including reinstatement and awards of compensation for past and future economic loss, distress and hurt feelings.
There is also a body of federal law that prohibits employers taking adverse action (meaning action that hurts or disadvantages an employee) because an employee possesses or has exercised a workplace right. Workplace rights include:
- benefits (such as minimum employment entitlements) and responsibilities (such as health and safety duties) under workplace laws;
- the ability to initiate or participate in a process or proceeding under a workplace law; and
- the ability to make a complaint or enquiry to a person having the capacity under a workplace law to seek compliance with that law (e.g., to a WorkSafe inspector or an inspector from the Office of the Fair Work Ombudsman).
Contraventions of these laws can attract prosecutions, fines, injunctions and orders for compensation.
Australia also has unfair dismissal laws that prohibit a termination of employment where the termination is harsh, unjust or unreasonable. However, these laws rarely apply to executives.
Release of claims from an executive
Releases cannot be obtained if they in any way restrict an executive's entitlement to make a claim under a statutory workers' compensation scheme that applies to injuries and illnesses caused by work or that relates to an executive's entitlement to the minimum amount of compulsory superannuation contributions.
The validity of a release agreement or deed (like any other agreement) can be challenged on grounds such as duress and unconscionability. For this reason, it would be prudent for an employer to give an employee an opportunity to obtain independent legal advice before asking him or her to sign a release agreement or deed.
Limitations and guidelines
As far as the common law is concerned, an employer and an executive can agree on whatever severance payments they believe are appropriate to their circumstances.
However, where executives are concerned, this position has been modified by provisions in the Corporations Act.12 These provisions are complicated and contain numerous qualifications and exemptions, but broadly speaking they restrict the payment of termination benefits to directors and, in relation to entities listed on the Australian Stock Exchange (ASX), key management personnel, to 12 months' average base salary, unless that benefit has been approved by the company's shareholders.
There are also some restrictions applying to public companies in relation to the giving of financial benefits (including termination payments) to related parties. Related parties include directors and spouses, and their parents and children.
Additionally, the ASX's Listing Rules prohibit officers of listed entities from being entitled to termination benefits if the value of those benefits, when combined with the benefits payable to other officers of an entity, would exceed 5 per cent of the equity of the entity, unless shareholder approval is obtained.
There are also some provisions in the Fair Work Act 2009 (Cth) that entitle employees (including executives) to certain minimum benefits on termination of employment. These benefits are notice of termination (or payment in lieu) of between one and five weeks (depending on length of service and age of the departing employee); payment of certain accrued but untaken leave entitlements (limited to annual and long-service leave); and severance pay in the event of a redundancy (ranging between four and 16 weeks' pay depending on length of service).
Terminations in connection with a change in control
If an employer is listed on the ASX, it must not allow an officer to receive any termination benefits (or any increase in them) simply because a change has occurred in the shareholding or control of that entity or any of its subsidiaries.
Involuntary termination for good cause
At an executive level, terminations of employment, whether involuntary or voluntary, and whether for good cause or without cause, are not restricted by legislation except to the extent that anti-discrimination and adverse action laws (discussed above) have an impact on this issue.
Leaving aside those statutes, the position in Australia is that executives can be terminated either with or without cause by the employer simply providing the executive with the appropriate period of notice (the amount of which is usually specified in the executive's employment contract) or by making a payment in lieu of that notice. As noted earlier, an employee can also be dismissed summarily (without notice) if the dismissal is for serious misconduct.
Australian law recognises that employers can behave in such a way that employees (including executives) can feel they have no alternative but to resign. This sort of forced resignation is treated as a dismissal and is referred to as a constructive dismissal.
Severance compensation on transfer of employment connected with a corporate transaction
The statutory redundancy scheme13 is subject to provisions that can exempt an employer from the obligation to pay severance pay where an offer of suitable alternative employment has been secured.
As noted above, there is a rule applicable to entities listed on the ASX that prohibits payments on a change in control.
Leaving these rules aside, this question is one that is ordinarily dealt with in an executive's contract of employment. That contract can specify when severance compensation is payable, including in circumstances of a change in control.
v Personal liability
Workplace health and safety
Federal workplace health and safety laws (which apply in the majority of Australian states) impose a positive obligation on directors; persons who make or participate in making decisions that affect the whole or a substantial part of a business; and persons who have the capacity to affect significantly a company's financial standing to ensure that the employer complies with its obligations under work health and safety laws. This is known as the due diligence requirement. Importantly, an officer who fails to comply with his or her due diligence obligations is exposed to the risk of prosecution and personal liability. This duty can be breached even if there has been no accident or prosecution of the employer.
Under Australia's federal employment laws14 (which apply to all corporations), a person who is involved in a contravention of a wide range of statutory provisions is deemed to have contravened those provisions him or herself. A person is involved in a contravention if he or she has:
- aided, abetted, counselled or procured the contravention;
- induced the contravention;
- been knowingly concerned in, or a party to, the contravention; or
- conspired with others to effect the contravention.
In that event, an individual can be prosecuted just as if he or she had personally committed the contravention. These laws apply to executives.
The types of contraventions covered by these accessorial liability provisions are provisions that:
- mandate minimum employment entitlements (such as wages, leave entitlements and termination entitlements);
- require compliance with industrial instruments (such as awards and enterprise agreements;
- prohibit adverse action (discussed in Section IV.iii); and
- prohibit sham contracting – the practice of treating employees as independent contractors.
Many duties are imposed on directors by statute (particularly the Corporations Act), common law and the laws of equity. One duty that should be brought to the attention of foreign executives who become directors of Australian companies is the duty to prevent insolvent trading: failing to prevent a company from incurring a debt when there were reasonable grounds for suspecting the company was insolvent.15 Breach of this duty is, effectively, a criminal offence that can attract not only substantial fines but also imprisonment.
vi The Banking Executive Accountability Regime
The Banking Executive Accountability Regime (BEAR) came into force on 20 February 2018. The regime is contained in the Treasury Laws Amendment (Banking Executive Accountability and Related Measures) Act 2018 (Cth) which amended the Banking Act 1959 (Cth).
The BEAR imposes a range of obligations on authorised deposit-taking institutions (ADIs) (i.e., banks, building societies, credit unions) and their accountable persons (i.e., senior executives and directors) in an attempt to increase accountability in these organisations for decisions and outcomes.
The BEAR applies to Australian branches of foreign ADIs as well as to Australian ADIs. In the case of large ADIs (assets of A$100 billion or more), the BEAR took effect on 1 July 2018. In the case of medium ADIs (assets of between A$10 billion and A$100 billion) and small ADIs (assets of A$10 billion or less), it took effect on 1 July 2019.
Notably, the BEAR stipulates that an ADI must:
- defer a specified portion of any variable remuneration of an accountable person for a specified period (the minimum period typically being four years from the date on which the decision was made to grant the variable remuneration);
- have a remuneration policy such that variable remuneration is to be reduced by an amount proportional to any failure to comply with accountability obligations (which may be a reduction to zero);
- ensure that the amount of any such reduction is not paid to the accountable person; and
- take reasonable steps to ensure that each of its subsidiaries that is not an ADI complies with the above requirements as if the subsidiary were an ADI.
As a result of the recent Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, it has been proposed that BEAR will be replaced by the Financial Accountability Regime (FAR). The Treasury released a Proposal Paper on 22 January 2020, which proposes to extend the remit of BEAR to all APRA-regulated industries and their senior executives. The objectives and essential structure of BEAR will be retained in FAR, but major changes are proposed including:
- FAR will be jointly administered by APRA and ASIC;
- FAR extends the definition of an 'accountable person' and accountable persons will also be required to take reasonable steps to ensure their entity is compliant with its licensing obligations; and
- FAR will introduce civil penalties for accountable persons and increase the maximum penalties that can be imposed on entities.
At present, the implementation of FAR is merely a proposal and no legislation has been drafted or debated.
V SECURITIES LAW
Australian corporate and securities law focuses mostly on forms of executive remuneration that involve securities (such as options over unissued shares and shares) or financial products (such as phantom equity or replicator plans, or restricted share units (RSUs)).
ii Securities disclosure obligations when issuing securities
Remuneration plans that involve the issue of securities,16 including share plans and option plans, are all subject to disclosure and fundraising regulation under Chapter 6D of the Corporations Act. At its most basic, that Chapter of the Corporations Act requires that any issue (and some sales) of securities must be made under a regulated form of disclosure document (such as a prospectus) unless an exemption applies.
A range of disclosure documents may be prepared under the Corporations Act with differing standards of disclosure, permitted uses and liability exposure. The most common form of disclosure document, a prospectus, must contain all the information that investors and their advisers would reasonably require to make an informed assessment of the rights and liabilities attaching to the securities and the assets and liabilities, financial position and performance, profits and losses, and the prospects of the issuer.17 Disclosure documents are lodged with the Australian Securities and Investments Commission (ASIC) and are subject to differing degrees of scrutiny depending on their nature. They are publicly available.
Any requirement to prepare a disclosure document is particularly onerous when seeking to implement a simple incentive plan.
Exemptions from disclosure
Fortunately, in most cases, preparation of a disclosure document can be avoided by relying on one of the statutory exceptions to disclosure or on one of ASIC's Class Order exemptions relating to employee share schemes.18
Failing this, it is possible to apply to ASIC for specific relief, although the circumstances in which this will be granted can be quite limited.
The statutory exemptions from disclosure are contained in Section 708 of the Corporations Act. The most relevant of these are:
- the senior manager exemption.19 An offer of securities does not need disclosure if the offer is made to senior managers of the body or a related body or certain relatives of the senior manager, or bodies corporate controlled by senior managers or their specified relatives. For these purposes, a senior manager means a person who is concerned in, or takes part in, management (regardless of the person's designation and whether or not the person is a director or secretary of the body);20 and
- small-scale offerings.21 An offer of securities does not need disclosure if:
- the offer is a personal offer;
- the offer does not result in the number of people to whom securities have been issued exceeding 20 in any 12-month period; and
- the amount raised by the body does not exceed A$2 million in any 12-month period.22
In calculating the 20-person and A$2 million limits, offers that qualify for another Section 708 exemption, offers made under a disclosure document under Chapter 6D and offers made outside Australia are not included.
In practice, the senior manager exemption is likely to apply to most plans that are limited to the most senior employees and directors. The small-scale offerings exemption will provide some coverage for broader-based plans for others who do not qualify as senior managers.23
ASIC general relief from disclosure obligations
ASIC has provided general relief from disclosure for incentive plans under ASIC Class Order [14/1000], which assists listed companies issuing equity securities. The key conditions for this relief are as follows:
- the offers must be made only to:
- full-time or part-time employees, or directors of the issuer or of an associated body corporate of the issuer;
- contractors or casual employees of the issuer or an associated body corporate who work a number of hours equivalent to at least 40 per cent of a comparable full-time position; or
- persons who will, upon accepting the offers, become employees, directors or contractors;
- the securities (or financial products) being offered must be eligible products (as defined in the Class Order [14/000]), which include:
- fully paid shares in an issuer in a class that has been continuously quoted on the ASX (or an approved foreign exchange) for the immediately preceding three months;
- options for the issue or transfer of such shares; and
- incentive rights (generally this term covers any right that is settled in or benchmarked against such shares, such as RSUs and phantom shares);
- options and incentive rights must be granted for no more than nominal monetary consideration; and
- the total number of shares issued under the Class Order or similar relief in the past three years must be less than 5 per cent of the total number of shares on issue at the time of the offer.
There are a number of other requirements that must be satisfied for a listed company to be able to rely on the relief under Class Order [14/1000].
A similar exemption (Class Order [14/1001]) applies for offers of equity awards by unlisted companies. The exemption potentially covers fully paid voting ordinary shares, as well as incentive rights and options over such shares, but is subject to a number of restrictive conditions.
- the total value of the awards being granted to any Australian-resident employee in any 12-month period must be no more than A$5,000;
- options or incentive rights cannot be granted for more than nominal monetary consideration, and in addition cannot have a more-than-nominal exercise or vesting price unless:
- the underlying shares have been continuously quoted on an approved stock exchange for at least three months at the time of exercise or vesting; or
- a valuation document,24 which is dated no earlier than one month before it is given, is given to participating employees no later than 14 days prior to exercise or vesting; and
- the grants must be accompanied by various disclosures, including a copy of the issuing company's most recent annual financial statements.
Disclosure obligations when issuing financial products
It is also possible that the requirements of Chapter 7 of the Corporations Act will apply to executive incentive plans.
Chapter 7 contains a separate (and analogous) disclosure regime for financial products (which are not securities).25 This most frequently applies when a right that is not a share or an option over unissued shares is being offered as part of remuneration, or there is a component of the arrangement that constitutes a derivative under the Corporations Act. A derivative is very broadly defined and essentially includes arrangements where, at a future point in time, a party will be obligated to provide consideration that is derived from the value of something else.26 This affects phantom equity or replicator plans since, by their nature, these plans pay employees an amount of consideration that is derived by reference to the value of shares or other securities.
As noted above, ASIC Class Orders [14/1000] and [14/1001] provide disclosure exemptions for the financial products that are typically available under phantom equity plans and RSU plans.
Under the Australian Financial Service Licence (AFSL) regime, a series of licensing requirements can apply where a person is taken to carry on a financial services business in Australia. Financial services can include providing financial product advice (including advice in respect of securities), dealing in a financial product or providing custodial or depository services.27 Issuers may most commonly attract the application of this regime where:
- they provide advice or recommendations in respect of an incentive plan;
- they issue or sell securities or financial products (there are limited exceptions for self-dealing which may apply when issuing securities such as shares or options over unissued shares, but does not apply to financial products, such as RSUs or phantom equity plans); or
- the plan structure involves the use of a trust to hold securities or financial products.
In some cases, it may be possible to seek case-by-case relief from ASIC. However, this is subject to ASIC policy and is granted in only limited circumstances. As a result, entities generally structure their incentive arrangements to avoid the need to comply with the AFSL regime. In situations where, for example, a trust-holding arrangement is desirable for other reasons,28 listed entities at least tend to make use of a dedicated AFSL holder who is licensed to provide the relevant services.29
On-sale of securities
The on-sale of securities or financial products by executives (e.g., the sale of shares acquired under an equity incentive plan) attracts a number of differing regulatory requirements. In brief, these include:
- insider trading: executives will need to be particularly mindful not to breach insider trading laws by selling securities or financial products when they have materially price-sensitive non-public information.30 Insider trading attracts serious penalties and is an area of particular focus for ASIC;
- secondary sales disclosure: the on-sale of securities or financial products acquired under disclosure exemptions to a person or entity in Australia within 12 months of the issue of the securities or financial products may also be subject to disclosure and licensing requirements under the secondary sale provisions of the Corporations Act;31
- share-trading policies: ASX-listed companies are required to have in place share-trading policies that regulate trading in their securities (including equity-based remuneration) by executives. Under share-trading policies, executives will be required to comply with fixed trading windows during which executives can trade in securities, and closed periods during which they cannot;32 and
- continuous disclosure requirements: ASX-listed entities (and directors) must comply with the continuous disclosure obligations in the Corporations Act and ASX Listing Rules.33 These require disclosure of notifiable interests held by directors and trades made by directors in the securities of their own entities within short prescribed time periods. The obligation for compliance is imposed on the entity by the ASX Listing Rules and the director under the Corporations Act.
Regulation of termination benefits
It is important to note that some equity plans can activate the restrictions on termination benefits34 mentioned in Section IV.iv. This can occur when an equity plan either accelerates vesting of equity benefits on cessation of employment or an employer exercises a discretion to allow an executive to retain an incentive (such as shares, options and bonus rights) when the executive ceases employment and would otherwise have forfeited those rights.
i Annual reports
Companies, registered schemes and other disclosing entities must prepare annual financial reports and directors' reports, unless exempted.35 Listed entities must include a remuneration report that sets out prescribed details regarding their remuneration arrangements.36 Particular emphasis is being placed on remuneration reports in the Australian market, with proxy advisers, institutional shareholders and shareholder associations all paying close attention to both the quality of disclosure and the settings of remuneration policies.
ii The two strikes rule
The Corporations Act contains a two strikes rule, which aims to provide shareholders of listed companies with greater control over high executive remuneration.
Under the two strikes rule, listed companies must put their remuneration report to their shareholders for a non-binding approval vote at the annual general meeting (AGM).37 If 25 per cent or more of eligible votes are cast against the remuneration report at two consecutive AGMs, the company must put a spill resolution to shareholders.38 If 50 per cent or more of the eligible votes are in favour of the spill resolution, the company must convene a spill meeting where all directors, except the managing director, may be dismissed by shareholder resolution and new directors appointed.39
This rule continues to receive large amounts of media attention, with corresponding levels of criticism from some segments of the business community. It has undoubtedly increased the focus of listed companies on the adequacy of their remuneration reports and remains contentious.
VII CORPORATE GOVERNANCE
i ASX Listing Rule approval requirements
ASX-listed entities are subject to numerous shareholder approval requirements related to executive remuneration. Most notably, shareholder approval is required for the following:
- issuing of equity securities to directors and other related parties, other than in excepted situations;
- increasing the total amount of directors' fees to its non-executive directors; and
- providing termination benefits to officers that in aggregate exceed 5 per cent of the value of the equity of the entity.40
ii Corporate governance principles
The ASX Corporate Governance Council has published a revised set of non-binding principles and recommendations for good corporate governance. In relation to remuneration, they contain recommendations regarding:
- remuneration committees, their composition and their operating processes;41
- reporting separately on an entity's policies and practices regarding the remuneration of non-executive directors, and the remuneration of executive directors and other senior executives;42 and
- having a written policy with respect to hedging the risk of participating in equity-based remuneration schemes.43
Although the principles and recommendations are non-binding, ASX-listed entities are required to report on their compliance with the ASX Corporate Governance Principles and explain the reason for any departures.44
VIII SPECIALISED REGULATORY REGIMES
ASX-listed entities are subject to additional regulation that does not apply to unlisted companies. This occurs under the Corporations Act 2001 (Cth) and ASX Listing Rules, and is discussed in Sections V, VI and VII.
IX DEVELOPMENTS AND CONCLUSIONS
Executive remuneration continues to be an area of great scrutiny, for listed companies in particular. The Australian market is vigilant and aware of remuneration-related issues, and these are frequently matters of political intervention and public commentary. With the introduction of the two strikes rule, ASX-listed companies are more focused than ever on communicating with stakeholders on matters of executive remuneration.
1 Sean Selleck and John Walker are partners, Erica Kidston is special counsel, Jonathan Kelt is a consultant and Alexandra Stead and Sinan Alnajjar are senior associates at Baker McKenzie. The authors would like to acknowledge the contributions made to earlier versions of this chapter by former colleagues Ellen Thomas, Michael O'Neill and Maria Pawelek, and to thank them for those contributions.
2 As employees must pay 85 per cent of the current market value for shares, this alternative does not seem popular.
3 The rate is 47 per cent for the fringe benefits tax year ending 31 March 2021.
4 Federal Commissioner of Taxation v. Everett  HCA 6; (1980) 143 CLR 440.
6 Note there are other jurisdictions with which Australia does not have a double tax agreement in place.
7 Generally, a person holding a temporary visa, and neither he or she nor his or her spouse is an Australian resident for social security purposes (e.g., an Australian resident citizen).
8 Koompahtoo Local Aboriginal Land Council v. Sanpine Pty Ltd (2007) 233 CLR 115.
9 General Billposting Co Ltd v. Atkinson  AC 118.
10 Kaufman v. McGillicuddy  HCA 63.
11 Crowe Horwarth (Aust) Pty Ltd v. Loone  VCSA 181.
12 Corporations Act 2001 (Cth).
13 Contained in the Fair Work Act 2009 (Cth).
14 Fair Work Act 2009 (Cth).
15 Corporations Act 2001 (Cth), Section 588G.
16 See Corporations Act Section 700(1) and Section 761A for a definition of securities.
17 See Corporations Act 2001 (Cth), Section 710 for a more comprehensive summary of the prospectus requirements.
18 ASIC Class Order [14/1000] or ASIC Class Order [14/1001].
19 Corporations Act 2001 (Cth), Section 708(12).
20 ASIC Corporations (Disclosure Relief – Offers to Associates) Instrument 2017/737.
21 Corporations Act 2001 (Cth), Section 708(1).
22 For options and partly paid securities, any amount payable upon exercise or if a call is made is deemed to be included in the amount raised.
23 A sophisticated investor exemption is also available that is more rarely useful given that most executives who would qualify for it would also qualify for senior manager exemption – broadly, where the amount invested by that person in the same class of securities is at least A$500,000 or an accountant verifies that the person has net assets of at least A$2.5 million or income of A$250,000 in the past two years: see Corporations Act 2001 (Cth), Section 708(8).
24 For this purpose, a valuation document is (i) a current disclosure document (e.g., an Australian-compliant prospectus) for an offer of shares in the same class as the shares to which the options or incentive rights relate; (ii) an independent expert's report that contains an opinion on the value of a share in the same class as the shares to which the options or incentive rights relate; or (iii) a copy of an executed agreement under which shares in the same class as shares to which the options or incentive rights relate are to be acquired on arm's-length terms by a third party that is not an associate of the issuing company and that specifies a value of a share in that class.
25 See Corporations Act 2001 (Cth), Section 761A and Chapter 7, Part 7.1, Division 3 for a definition of financial products.
26 Corporations Act 2001 (Cth), Section 761D.
27 Corporations Act 2001 (Cth), Section 911A.
28 Generally, this is implemented for taxation or accounting reasons, but also attracts some practical benefits for publicly listed companies.
29 Notably, the professional share registry and custodial service providers generally provide this service.
30 See Corporations Act 2001 (Cth) Chapter 7, Part 7.10, Division 3.
31 Corporations Act 2001 (Cth) Sections 707(3)–(4) and 1012C(6)–(7).
32 ASX Listing Rules 12.9 to 12.12.
33 ASX Listing Rule 3.19A; Corporations Act 2001 (Cth), Section 205G.
34 Corporations Act 2001 (Cth) Part 2D.2.
35 Small proprietary companies are exempt from the requirement to prepare reports unless they are directed otherwise or are controlled by a foreign company, or have one or more shareholders who have been issued shares under Australia's crowd-sourced funding regime, and small companies limited by guarantee are exempt unless they are directed otherwise: Corporations Act 2001 (Cth), Section 292.
36 Corporations Act 2001 (Cth), Section 300A.
37 Corporations Act 2001 (Cth), Section 250R(2).
38 Corporations Act 2001 (Cth), Sections 250U to 250V.
39 Corporations Act 2001 (Cth), Sections 250V and 250W.
40 ASX Listing Rules 10.11 to 10.19.
41 Recommendation 8.1 of the Corporate Governance Principles and Recommendations, fourth edition (2019).
42 Recommendation 8.2, ibid.
43 Recommendation 8.3, ibid.
44 ASX Listing Rule 4.10.