The Executive Remuneration Review: Switzerland
While the remuneration of executives has received broad media attention in the last 20 years, the law on remuneration as well as the employment law has largely remained the same for top executives and for blue-collar workers. In principle, the same employment contract rules, statutory rules and tax rules apply, with the exception of certain rules for publicly listed companies (the 'say-on-pay' rules) and rules on the remuneration in financial institutions.
Say-on-pay rules were introduced when the Swiss people approved a public initiative against excessive salaries of top executives in 2013. Based on the public vote, the Federal Ordinance against Excessive Compensation in Public Corporations was enacted. It introduced binding shareholder votes on board and executive compensation and prohibits certain types of severance payments and transaction-related bonuses (see Sections IV.iii, VI and VII). Swiss corporations have successfully adopted these rules into the corporate practice, and there are rarely issues with their application. Despite these rules, executive pay in Switzerland remains one of the highest in the world.
In addition, the financial crisis triggered additional regulation of remuneration schemes of financial institutions. No statutory limits for the compensation of executives were introduced, but the Swiss Financial Market Supervisory Authority FINMA issued Circular 2010/1 on minimum standards for remuneration schemes of financial institutions, which contains rules on corporate governance and structure of remuneration schemes, in particular variable compensation (see Section VIII).
i Income tax for employees
Executives who are tax residents of Switzerland are subject to Swiss federal, cantonal and communal income tax on their worldwide income, whether paid in cash or in kind and regardless of source (i.e., whether paid from the executive's Swiss employer or a Swiss or foreign group company).
Certain exceptions apply to this rule: income from enterprises, permanent establishments or real estate situated outside Switzerland is exempt from Swiss income tax (but will be taken into account when determining the applicable tax rate). Further, capital gains realised on private assets (other than real estate situated in Switzerland) are exempt from Swiss income tax.
Swiss federal, cantonal and communal income tax is imposed at progressive tax rates. The income tax rate depends on a number of factors, including the executive's (and, if married, his or her partner's) total annual income (e.g., employment income, investment income (such as dividends, interest), real estate income, etc.), his or her Swiss place of tax residence (i.e., canton, commune), whether the executive is married or single, and other factors.
Swiss nationals and holders of a residency permit C (Niederlassungsbewilligung) as well as spouse of such person are not subject to wage tax withholding. Rather, income tax is imposed on the income as reported in their annual income tax return. All other executives are subject to wage tax withholding. If the annual total income (from employment subject to wage tax withholding) exceeds 120,000 Swiss francs per year, the foreign executive must file a tax return. Income tax imposed at source is credited against tax imposed on income as declared in the annual income tax return. The same applies, irrespective of the amount of employment income subject to wage tax withholding, if the executive earns other types of income, such as investment income or real estate income, among others.
Non-Swiss tax resident foreign nationals are only subject to tax on income from performing a gainful activity in Switzerland (and certain other types of Swiss source income, such as directors' fees). Non-resident foreign national workers are subject to wage tax withholding. This tax is final. The executive is not required to file a tax return; exceptions may apply to foreign nationals domiciled in an EU Member State based on the agreement on the free movement of persons, in which case the employee has a right to file a tax return under certain conditions. As regards taxation of foreign nationals, exceptions may apply to foreign nationals domiciled in a country with a double taxation treaty with Switzerland who are assigned to Switzerland for no more than 183 days by an employer. Subject to the conditions in the applicable treaty, the employee's state of residence can continue to levy income taxes on dependent personal services rendered by the employee in Switzerland. In this case, Switzerland cannot impose income tax on the employment income for work conducted in Switzerland. If income is subject to Swiss income tax, depending on the applicable treaty, if any, income tax imposed by Switzerland will be exempt from income tax in the executive's state of tax residence or will be credited against income tax imposed by that state.
ii Taxation of employee incentive plans
Regarding general principles, as a rule, every kind of equity (e.g., shares) or entitlement to equity (e.g., options or restricted stock units (RSUs)) or to a payment depending on equity performance (e.g., phantom shares or stock appreciation rights) attributed to an employee qualifies as equity-based incentives for Swiss tax purposes.
As a general rule, equity-based incentives qualify as employment income whenever there is a nexus between the equity-based incentive and the employment, irrespective of whether the employee receives equity-based incentives from the group's top company or any other affiliate of the employing entity.
If shares received as part of employment income (whether resulting from a direct allocation of shares or following the vesting of equity-based awards or the exercise of options) are subject to transfer restrictions, for purposes of calculating the income tax base, a discount of 6 per cent per year applies (capped at 44.161 per cent in case of a restriction of 10 years, and pro-rated to take into account fractions of a year).
Capital gain realised by the executive upon the sale of the shares generally classifies as tax-free capital gain, unless the executive qualifies as professional securities dealer for income tax purpose (e.g., for reason of frequent dealings in securities or debt-financed acquisition of securities). If the shares upon grant (or vesting in case of equity-based awards such as RSUs or exercise in case of options) have been valued based on a recognised valuation method (instead of fair market value), such valuation method will in principle again be applied upon sale of the shares for purposes of determining the amount of tax-free capital gain. As a result, any increase in value of the shares that is based on the valuation of the shares applying such recognised valuation method constitutes a tax-free capital gain, whereas any residual amount (i.e., the difference between the actual sales price and the value of the shares as determined by applying the recognised valuation method) constitutes taxable employment income subject to income tax and social security charges.
As a rule, share awards are taxed at grant. Income tax is imposed on the fair value of the shares, less the purchase price paid by the executive for the shares, if any. If the shares are subject to transfer restrictions, the fair value of the shares will be discounted (see above). An early termination of the transfer restrictions gives rise to taxable income (claw-back taxation; reversal of the unjustified portion of the discount due to early termination of the transfer restriction).
Employee stock options
As a rule, employee stock options are subject to taxation upon exercise. Income tax is imposed on the fair value of the shares received upon exercise of the stock options, less the strike price, if any. As an exception to this rule, unrestricted tradable stock options are taxable at grant in which case income tax is imposed on the option price as traded on the date of grant, less the price paid by the employee for the option, if any.
RSUs, performance share units or similar instruments
RSUs, performance share units (PSUs) or similar instruments are subject to taxation upon vesting. Other than that, the same rules apply as for employee shares.
Phantom shares, stock appreciation rights (SARs) and any other type of equity-based cash settled compensation schemes not listed above are subject to income taxation upon payment.
iii Social security charges for employees
As a rule, any remuneration the executive receives for performing his or her work, including benefits from any employee incentive plan, is subject to social security contributions.
The Swiss Federal Social Insurance Office has published guidelines for income earned from employee incentive plans, which essentially provide that the social security charges become due at the same time and on the same base as the income tax liability (which means that any tax discount for restricted employee shares is taken into account for social security purposes).
The following social security rates apply in 2020:
- 1st pillar coverage of old age and survivorship (AHV): 8.7 per cent (no cap).
- 1st pillar coverage of disability (IV): 1.4 per cent (no cap).
- Coverage of salary payment in case of military service and motherhood (EO): 0.45 per cent (no cap).
The total rate of 10.55 per cent is to be shared equally by the employer and the employee.
Annual wages of up to 148,200 Swiss francs are, in addition, subject to contributions for coverage of unemployment (ALV; 2.2 per cent to be shared equally by employer and employee) and mandatory occupational (payable by employer) and non-occupational (payable by employee) accident insurance. A surcharge of 1 per cent is imposed on annual wages exceeding 148,200 Swiss francs for contributions for ALV, which surcharge is to be shared equally by the employer and the employee (i.e., 0.5 per cent each). The surcharge is currently not capped.
The employer is liable to withhold social security contributions from the executive's salary and pay the withholdings, together with its own share, to the competent social security authorities. Different from the employee's share of social security contributions, which may be borne by the employer (in which case such shifting of contributions to the employer constitutes taxable income of the employee), the employer's share of social security contributions must, by mandatory Swiss law, be borne by the employer and cannot be shifted to the employee.
Swiss law provides for the maintaining of occupational pension benefits schemes in excess of state pension benefits (2nd pillar scheme). It is mandatory for employers to maintain minimum pension benefits (mandatory benefits) in such schemes, and it is possible to maintain additional, non-mandatory top-up benefits up to a certain level (non-mandatory benefits, collectively 2nd pillar benefits).
The maximum insured income in 2020 is as follows:
- Mandatory benefits scheme: 85,320 Swiss francs (less 24,885 Swiss francs, known as 'coordination deduction').
- Non-mandatory top-up benefits scheme: 853,200 Swiss francs.
The pension plan rules define which income is pensionable. Normally, bonus and income resulting from employee incentive plans are not pensionable. Within the above limits, plan rules may, however, provide that such income is included in the pensionable salary in full or in part.
Pension contribution rates depend on the age of the executive. As a default, contributions are shared equally between employer and executive. Benefit plans for executives often provide that the employer bears a higher share or even 100 per cent.
Contributions to these 2nd pillar pension schemes are deductible from employment income (and other income) by the employee and from taxable income by the employer.
iv Tax deductibility for employers
Cash remunerations paid by Swiss employers to their employees are generally genuine business expenses for the Swiss employing company and thus tax-deductible. Expense resulting from equity awards is generally also tax-deductible to the extent such expense is reported in the employers' income statement (P&L).
The employer's share in social security and pension contributions is fully tax-deductible.
Tax planning and other considerations
i Internationally mobile executives
In cross-border situations, where incentive awards partially vest while the executive is a tax resident in Switzerland, the income earned is time-prorated for income tax purposes. The portion of the income that is subject to Swiss income tax is determined based on the time spent by the executive in Switzerland during the vesting period. This concept applies in both inbound and outbound cross-border situations and follows the recommendations of the OECD. If an executive exits Switzerland, as a rule, income tax on such portion of his or her income subject to Swiss income tax is imposed by way of wage tax withholding, which is due by the former Swiss employer of the executive. In addition to income tax, as a rule, the income is subject to Swiss social security contributions.
Where an executive conducts employment in two or more jurisdictions and | or for two or more employers, international treaties such as the regulations enacted by the EU on the coordination of social security (which apply also to Switzerland) and bilateral social security treaties need to be considered.
Subject to satisfaction of the conditions under the applicable EC Regulation and the bilateral social security treaty, respectively on the secondment of workers, the executive may classify as a posted employee and continue to be covered by and pay contributions to the foreign social security system of the country from where the executive is posted to Switzerland.
ii Expatriate tax status
Senior executives who are assigned to Switzerland temporarily by their foreign employer may benefit from certain tax-free allowances and tax-deductions, including the executive's relocation costs to and from Switzerland, double housing costs and private schooling fees for the expatriate's children. These allowances and tax-deductions will be granted only to executives who are assigned to Switzerland on a fixed-term employment contract not exceeding five years and are subject to a number of additional conditions.
iii Business expenses
Reimbursement of expenses
Usually, Swiss employers enact a policy governing the reimbursement of expenses incurred by employees in company business and submit such policy to the competent tax authorities for approval. Payments made to an employee to compensate for expenses incurred on company business are not taxable. The approval of the policy by the competent tax authorities exempts the employer from certain compliance obligations.
Payment of lump sum representation allowance
Swiss employers often pay executives a lump sum representation allowance to reimburse the executive for expenses incurred in representing the company, acquiring new and retaining existing customers etc. The lump sum representation allowance reimburses the executive for all minor expenses up to, for example, 50 Swiss francs per single transaction. Expenses incurred for single transactions exceeding this threshold may be submitted to the employer for reimbursement. The lump sum representation allowance is tax-free and usually may be as high as about 24,000 Swiss francs per year or 2,000 Swiss francs per month. The specific amount that the Swiss tax authorities accept as tax-free depends on a number of factors, including the executive's specific function for the Swiss employer (e.g., CEO, CFO, etc.) and the annual gross income. In addition, the practice of the various Swiss cantonal tax administrations is not uniform and the accepted amounts may vary.
i Basic rule: No special rules for executives
Swiss employment law is primarily governed by the Swiss Code of Obligations. These rules apply to all employees, and, in principle, there are no special rules for executives. The employment law rules also apply to top executives, other than the members of the board whose legal relationship is outside of employment law for lack of a subordination relationship with the company.
While appointment and removal of executives from corporate functions, such as membership in corporate bodies, and related obligations, are governed by corporate law, the employment side of the relationship remains governed by the standard rules of employment law.
Some employment law rules are interpreted differently in case of executives, however. In particular, a higher degree of loyalty is expected of executives. In addition, some protective rules of the labour act do not apply to top executives, who do not benefit from rules on remuneration of extra work, among others.
There is a principled distinction between two forms of compensation in Swiss law: salary and 'gratification'. The salary component consists of the sums periodically and unconditionally paid in cash by the employer (normally a fixed sum, sometimes a participation in profits, theoretically also a commission).
Modern compensation schemes for executives in Switzerland regularly provide for variable incentive schemes: short-term incentives and long-term incentives. Part of the incentive is often paid out annually, in cash, shares or other equity instruments. Another part of the compensation remains blocked for three to five years.
These compensation schemes normally provide for additional rules on adjustment of the compensation (malus or bonus) or its cancellation (forfeiture) or even repayment (clawback), in particular in case of breaches of the employment agreement, unethical behaviour, violation of a non-compete undertaking, or adjustments to the financial statements.
Such additional rules are generally enforceable under Swiss law if the incentive qualifies as 'gratification' and not as salary. The courts use several criteria to distinguish the two types of compensation. The most important are:
- A gratification can only exist if the employer has full discretion with regard to the payment of the incentive and its amount. If the amount of the incentive is determined by objective criteria (EBIT, sales, etc.), the incentive qualifies as salary.
- The incentive is an accessory to the base salary, and not the main portion of the compensation. Otherwise part of the incentive will be re-qualified as salary. This second criteria only applies if the total compensation does not exceed five times the median salary in Switzerland in the relevant year (i.e., approximately 380,000 Swiss francs).
If the incentive qualifies as salary, it must be paid unconditionally, and additional rules on blocking periods, malus, forfeiture and clawback are not enforceable.
iii Restrictions applicable to executives of listed Swiss corporations
The Federal Ordinance against Excessive Compensation in Public Corporations (Compensation Ordinance), which applies to Swiss-incorporated companies listed on a Swiss or foreign stock exchange (see VII below for details), prohibits certain forms of compensation of the members of the board of directors and executive management, including:
- severance; and
- certain bonuses in connection with M&A transactions.
The termination notice period for these individuals must not exceed twelve months. Fixed-term service or employment contracts must not exceed one year. Compensation (including salary, bonuses, benefits, etc.) can be paid during the notice period.
Members of boards of directors or executive management who intentionally breach the above rules may be subject to criminal sanctions.
For the binding annual say on pay vote, see Section VII.
The Compensation Ordinance further requires that the articles of association of the respective company limit the number of board and executive management positions that any director or executive may hold in other companies. The Compensation Ordinance does not stipulate a maximum number, though.
Swiss law does not require directors, executives or employees to hold securities of their employer, nor restrict such holdings. However, a number of public companies have adopted shareholding guidelines at executive management level. Swiss law does not provide for anti-hedging rules either.
If directors, executives or employees hold securities, the rules set out below must be complied with.
i Insider trading rules
Swiss law prohibits insider trading and provides for criminal sanctions of up to five years of imprisonment as well as administrative sanctions. Most public companies have enacted internal regulations that govern the trading in their securities and typically provide for blackout periods during which trading is prohibited. Regulated financial institutions are subject to additional organisational requirements set out in the circular on market abuse issued by FINMA.
The insider trading rules may restrict companies in making 'out of the ordinary course' equity grants to employees or directors during a blackout period or if otherwise in possession of inside information.
ii Registration requirements
As a general rule, shares or options may be awarded under an employee participation plan to employees and directors in Switzerland without any government authorisation, regulatory notification, filing or registration, provided that the options granted and the shares to be acquired are not listed or intended to be listed on a Swiss trading venue, or relate to shares already listed.
Securities offered to current or former members of the board of directors or executive management or employees are expressly exempt from the obligation of the issuer to prepare a prospectus in Switzerland.
iii Reporting requirements
Pursuant to the Directive of SIX Exchange Regulation on Disclosure of Management Transactions, the members of the board of directors and executive management of a company with primary listing on the SIX Swiss Exchange must, as a general rule, report transactions in equity securities, options and related financial instruments to the company within two trading days. Financial instruments include contracts that provide or permit a cash settlement and other contracts for difference whose performance depends on the market value of the equity securities. The company then has to notify within three trading days following receipt of the notification the transaction – on a no-name basis – to the SIX Exchange Regulation, which publishes the information on its website. Companies must ensure that their directors and executives comply with their reporting obligations.
The reporting obligation is triggered by any acquisition or disposal which is made under the control of the director or executive and which has an effect on his or her assets. This includes securities acquired by an executive's bank based on an asset management agreement. Transactions carried out under the significant influence of a director or executive by spouses, persons living in the same household, controlled companies or other related parties are also reportable.
Transactions based on a service or employment agreement or as part of a compensation scheme are exempt from reporting if the decision whether to carry out the transaction is not up to the director or executive (i.e., as long as, for example, the executive cannot choose to receive the bonus in shares or cash). Option grants under an employee option plan do not trigger reporting. Once the director or executive exercises the options or sells the securities, a notification is required.
iv Restrictions on cash settlement of stock options
Swiss companies listed on a Swiss exchange and foreign companies with a main listing on a Swiss exchange are generally subject to the Swiss tender offer rules. If a tender offer extends to (unlisted) employee options, these rules must be observed. The tender offer rules also apply if the (target) company acts in concert with the offeror and intends to repurchase employee options or modify the terms of equity awards. Cash settlement of employee options is as such not restricted.
i Disclosure requirements for listed companies
Listed Swiss corporations, irrespective of their size, must prepare an annual compensation report, which must disclose the following:
- the amount of compensation paid or granted to current (and under certain circumstances, former) directors on an aggregate and individual basis;
- the amount of compensation paid or granted to current (and under certain circumstances, former) members of executive management on an aggregate basis and, with respect to the highest paid member only, on an individual basis;
- loans and credits granted to current (and under certain circumstances, former) directors and members of executive management; and
- shareholdings in the company (as well as conversion and option rights) held by current directors and members of executive management and related persons on an individual basis.
The term 'compensation' is defined broadly and includes any fees, salaries, bonuses, shares, options, equity instruments, fringe benefits and perquisites, benefits in kind, pension contributions, and such like. Non-cash compensation must be valued at grant and included in the above disclosure. There is no requirement to disclose 'realised pay'.
In addition, companies (irrespective of their jurisdiction of incorporation) listed on the SIX Swiss Exchange must disclose in their corporate governance report:
- the main principles of their compensation system;
- the method of determining the compensation, including the respective authorities and procedures;
- the rules in the articles of association regarding compensation, loans and certain pension benefits of members of the board of directors and executive management; and
- for non-Swiss companies only: information equivalent to the disclosure in the compensation report required from listed Swiss corporations.
The detailed terms of employment and service agreements must not be disclosed, and the agreements must not be publicly filed.
ii Disclosure requirements for private companies
Privately held Swiss companies are generally not required to disclose any information about their compensation policy or compensation actually paid.
iii Further disclosure requirements
Accounting rules (such as IAS 24) require the disclosure of certain aspects of the compensation of key members of management.
As a matter of law, the board of directors of a Swiss company is responsible for the remuneration governance, unless delegated to a board committee or, to the extent permissible, the company's management.
Any Swiss corporation listed on a Swiss or foreign stock exchange, irrespective of its size, must comply with the remuneration-related governance rules under the Compensation Ordinance. Companies incorporated outside Switzerland, even if listed on a Swiss stock exchange, are not subject to these rules.
The Compensation Ordinance requires the following:
- The shareholders' meeting must approve annually, and in (at least) two separate and binding votes, the compensation for the board directors and for the executive management. The approval relates to the (maximum) aggregate amount of compensation payable (in any form, i.e., cash, shares, options, benefits in kind, fixed or variable) to each body. Companies have significant flexibility in implementing these requirements and can determine a tailor-made say-on-pay regime in their articles of association (which need to be approved by shareholders). For example, companies can opt to hold:
- a retrospective vote on the actual compensation paid;
- a prospective vote on a maximum compensation amount (cap); or
- a combination of the above (such as a prospective approval of a maximum amount for fixed compensation elements and retrospective approval of short-term bonuses).
- In line with the recommendation of the Swiss Code of Best Practice for Corporate Governance, the majority of Swiss listed companies in addition submits the compensation report to an advisory shareholder vote.
- The articles of association must set out the key principles for any equity- or performance-based compensation paid to members of the board of directors or executive management. The articles can be kept generic.
- The board of directors must establish a compensation committee at board level. Its members are individually elected by the shareholders' meeting for a one-year term. Re-election is permissible. Other than the Swiss Code of Best Practice for Corporate Governance (and the voting guidelines of most proxy advisors), which recommend that all members of the compensation committee be non-executive and independent, the Compensation Ordinance does not impose such requirement. The main principles regarding the compensation committee's powers and responsibilities must be determined in the articles of association; the details can be set forth, for example, in the committee charter. The committee can have decision authority or may only have an advisory role, or a combination thereof.
- Swiss pension funds are required to exercise their voting rights on certain subject matters, such as board elections and the say on pay votes.
Owing to the shareholder votes on compensation amounts, the compensation report and the compensation committee members, proxy advisors such as ISS and Glass Lewis exert significant influence. Swiss companies (particularly without an anchor shareholder) are widely following the principles set out in their voting guidelines.
The articles of association may provide for an adequate process in the event of a negative vote, including the possibility to continue to pay out compensation on a conditional basis. In addition, the articles of association may provide for amounts reserved for new hires. This avoids the necessity to convene a shareholders' meeting in case of changes on the executive management board. Other than the approval of the (maximum) aggregate amount of compensation, no other shareholder approvals are required. In particular, equity incentive or option plans do not require shareholder approval. Further, unions, employee representatives or Swiss authorities do not need to approve compensation arrangements or plans.
Other than for certain financial institutions (see below), Swiss law does not impose any requirements related to malus or clawback of remuneration previously paid in the event of a financial restatement, misconduct, adverse change in business or other circumstance.
Specialised regulatory regimes
Special rules apply to the remuneration in the Swiss financial industry. FINMA issued a circular in October 2009, which was last amended in 2016.2 Remuneration in the banking and insurance industry has to comply, inter alia, with the following principles and guidelines:
- the remuneration scheme must be simple, transparent, implementable and oriented towards the long term;
- the structure and level of total remuneration have to be aligned with the firm's risk policies and designed so as to enhance risk awareness;
- any variable remuneration has to be designed to be dependent on the long-term success of the firm and be allocated based on sustainable and justifiable criteria that reflect the firm's business and risk policies;
- serious violations of internal or external rules must result in a reduction or forfeiture of variable remuneration (malus);
- a portion of the remuneration needs to be deferred and be subject to the future success of the institution;
- control functions must be remunerated in a way so as to avoid conflicts of interest; and
- as part of the annual reporting, the board must prepare a remuneration report, which discloses the implementation of the remuneration policy and rules; certain institutions must also include disclosure in line with the remuneration-related Pillar III reporting.
The circular applies to large banks, securities dealers and financial groups and conglomerates that are required to maintain equity capital of at least 10 billion Swiss francs, and insurance companies, insurance groups and conglomerates that are required to hold equity capital of at least 15 billion Swiss francs, and all their respective employees, managers and members of the board of directors.
FINMA recommends that all other Swiss-regulated financial institutions take these guidelines into account when designing their remuneration system. In addition, FINMA has the discretion to require financial institutions, on a case-by-case basis, to apply the guidelines (or selected rules thereof).
The legal validity and enforceability of the circular is not settled. Nevertheless, the rules stipulated therein have set a standard of best practice in the Swiss financial industry.