The Impact of Code Section409A on Global Compensation

Plans

April 27, 2006 11:30 am – 12:30 pm

Fredric S. Singerman, fsingerman@seyfarth.comDavid M. Weiner, dweiner@seyfarth.com

Partners, Seyfarth Shaw LLPand

William J. Dunn, willam.j.dunn@us.pwc.comPricewaterhouseCoopers

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Background:Section 409A

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BASICS

θ America Jobs Creation Act of 2004

θ “Deferred compensation” that is noncompliant isimmediately taxable

θ 20% excise tax on service provider, plus interestat underpayment rates

θ Compliant document required

θ New guidance expected in later this year

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What is Nonqualified DeferredCompensation?

θ Any arrangement under which employee (orother service provider) has a “legally bindingright” during a taxable year to compensationwhich has not been actually or constructivelyreceived but which will be payable to the serviceprovider in a later tax year

θ No legally binding right if compensation can beunilaterally reduced or eliminated by theemployer after services performed

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What Types of Arrangements areDeferred Compensation?

θ SERPs (supplemental executive retirementplans)

θ Excess plans (401(k) wraps or othersupplements to qualified plans)

θ Salary and/or Bonus deferrals

θ Phantom stock or restricted stock units

θ Discounted SARs (stock appreciation rights)

θ Deferred compensation for outside directors,non-employees

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What is NOT Deferred Compensation?

θ Certain Equity-based Compensation

♣ Incentive stock options and non-discountedstock options and SARs

♣ 423 employee stock purchase plans

θ Restricted Stock Awards

θ Short-Term Deferrals

θ Broad-based foreign retirement plans

θ Qualified Retirement Plans

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Short-Term Deferrals

θ Not deferred if compensation is paid by thelater of the date that is 2-1/2 months from theend of first tax year (either service provider orservice recipient) in which amount is vested

θ Vesting: “subject to a substantial risk offorfeiture” requires further service

θ Some unforeseeable administrative delay isacceptable

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What types of limits are imposed underSection 409A?

θ Timing and form of deferral elections

θ Timing and form of distributions

♣ Termination of employment, hardship,disability and “change in control”

♣ Specified events or specified date only

♣Change in election requires 5 year delay

θ No acceleration of time or schedule of payment

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6-Month Delay for Key Employees ofPublic Companies

θ Distributions tied to separation from service mustbe delayed at least 6 months beyond separation(but not later than death) for “key employees” ofpublic companies (defined to include companiesin controlled group with stock traded on anyestablished securities market which includesforeign exchanges and any over-the-countermarkets)

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Six-Month Delay

θ Key employee is top 50 compensatedofficers earning at least $140,000 (asindexed) plus certain shareholders

θ Look at 12-month period ending on anidentified date; if key employee on identifieddate then subject to 6-month delay for the12-month period starting the 1st day of the 4th

month after the identification date

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Effective Date

θ Effective 1/1/05 for deferrals earned or vestedon or after 1/1/05

θ Grandfathered deferrals:

♣ plan in place before 10/3/04

♣ no material modifications since 10/3/04

θ Transition Rules

♣ New elections by 12/31/06

♣ Plan documentation by 12/31/06

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Application to Parent CompanyArrangements and Expatriate &Impatriate Employees

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Excluded Foreign DeferredCompensation Arrangements

θ Contributions excludable under bilateralincome tax treaty

θ Participation in a broad-based foreign plan ofa non-US employer by a nonresident alienand certain resident aliens (other than greencard holder)

θ Participation in a broad-based foreign plan ofa non-US employer, with respect tononelective deferrals of foreign earnedincome up to Section 415 limits

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Excluded Foreign DeferredCompensation Arrangements

θ Any social security system of a foreignjurisdiction that is subject to a totalizationagreement with the US

θ Any government-mandated plan that is part ofthe foreign jurisdiction’s social security system

θ De minimis amounts ($10,000 or less)deferred by a non-US employer to a foreignplan based upon a nonresident alien’sservices performed in the United States

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Parent Company ArrangementsExtended to US Employees

θ Section 409A will apply to deferredcompensation otherwise taxable in the US♣Do home country incentive compensation

arrangements that provide for the deferral ofincome comply with Section 409A?o Consider vesting requirementso Consider employer discretion over timing

of payment♣Off-shore funding of arrangement

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Impatriate and ExpatriateArrangements

θ Continuing participation in foreignparent company plan

♣ previously earned and vestedamounts paid in the US

♣ previously earned amounts thatbecome vested based on US service

♣ amounts earned in the US (considercompliance issues above)

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Impatriate and ExpatriateArrangements

θ Severance Agreements♣ Safe-harbor exception for severance upon involuntary

termination limited to 2 x Section 401(a)(17) limit($220,000), with payments ending by 2nd year afteryear of termination

♣ 6 month delay requirementθ Certain reimbursements exempted if paid by end of

second yearθ One-off arrangements pose significant issues:

♣ Is compensation subject to a “good reason” provisiondeferred compensation?

♣ “Gardening Leave” may be termination of employment♣ Acceleration of deferred compensation

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Application to Global EquityArrangements

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Pitfalls: Equity Compensation

θ Modifications, extensions or renewals may bedeemed a new grant which could cause 409Atreatment to apply

θ Acceleration of vesting not a modification

θ Reduction in exercise price deemed a newgrant

θ Extension of exercise period may be OK if notbeyond 15th day of 3rd month after date awardwould have expired or, if later, end of calendaryear in which award would otherwise expire

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Problems with foreign equity plans

θ Options granted below fair value

θ Options over shares that do not qualify asservice recipient stock

θ Offshore trust funding

θ Permitted distribution violations

θ Broad use of RSU’s which do not qualify forSection 83 (property) safe harbor

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Fair value grants

θ Options in certain countries are granted at some type ofpre-grant average traded value (e.g., France)♣ US expats may participate in these plans

θ Proposed Regs provide that fair market value may bebased upon a 30 day average selling price before or afterthe grant, if the option grant commitment is irrevocablymade before the beginning of the specified period, andthe valuation method is used consistently for grants ofstock rights under the same and substantially similarprograms.

θ Discounted stock options and SAR’s can be amended toprovide a fixed distribution date through December 31,2006

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Options over other classes of stock

θ Under Section 409A Service Recipient Stock canonly be common stock♣ Must be the class of common stock that has the

highest aggregate value of any class of commonstock of the corporation, determined on the grantdate

♣ Stock cannot have preference as to dividends orliquidation rights

♣ May include ADRs if the stock to which the ADRsrelate would otherwise meet all otherrequirements

θ Foreign equity plans (particularly in the UK) oftengrant options over special classes of stock

θ These options will not qualify as service recipientstock and will not qualify for the option safe harbor

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Offshore funding

θ Limitations under corporate law on the use of Treasurystock in many foreign countries prompts companies touse offshore trusts as holding devices for equitycompensation plans

θ These offshore trusts will violate section 409A to theextent the employee has a vested right to payment ofplan benefits

θ Watch out for good leaver provisions

θ Are options a problem if the underlying shares are heldoffshore?

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Permitted distributions

θ Foreign plans often provide for distributionarrangements that do not meet thepermitted distribution rules, e.g,

♣ Employer discretion to acceleratepayment

♣ Plans that allow payment uponseparation from local service, but notfrom separation from corporate service

♣ Plans which call for change of controlpayments that do not meet qualifiedSection 409A change of control rules

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Questions?

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