OBLIGACIÓN TRIBUTARIA ADUANERA

Many companies have adopted change-in-control protections for senior management. Typically, these protections include change-in-control sev- erance or employment agreements or, increasingly, severance protection plans. A change-in-control employment or severance protection agree- ment or plan often becomes effective only upon a change in control or in the event of a termination of employment in anticipation of a change in control. A standard form of agreement or plan usually provides for a two- or three-year term after the change in control during which time the status quo is preserved for the executive in terms of duties, responsibilities and

employee benefits. In general, the event that the status quo is not pre- served and the executive resigns or the executive’s employment is termi- nated by the company, the executive would be entitled to severance pay (typically, a multiple of base salary plus an annual bonus amount).

Most change-in-control employment or severance protection agreements and plans also contain provisions addressing the so-called “golden para- chute” excise tax. The federal golden parachute tax rules subject “excess parachute payments” to a dual penalty: the imposition of a 20% excise tax upon the recipient and nondeductibility of such payments by the paying company. Excess parachute payments result if the aggregate payments received by a “disqualified individual” that are “contingent on a change in control” equal or exceed three times the individual’s “base amount” (the average annual taxable compensation of the individual for the five years preceding the year in which the change in control occurs). In such a case, the excess parachute payments are equal to the excess of (1) such aggre- gate change-in-control payments over (2) the employee’s base amount. In other words, the excise tax and nondeductibility rules apply not just to the excess over three times the base amount, but, once triggered, apply to the whole amount in excess of the base amount.

Three approaches to dealing with golden parachute tax penalties in change-in-control agreements and plans generally are taken:

• payments can be “grossed up” so that the employee is in the same after-tax position as if there were no excise tax;

• payments that are contingent on a change in control can be “cut back” to 299.9% of the base amount, so that no payments are considered parachute payments; and

• payments that are contingent on a change in control are cut back only if the result is to give the employee a larger after-tax return than if the payment were not cut back (a so-called “bet- ter-off cutback”).

After an analysis of the amounts involved, many companies historically adopted a “gross-up” provision in order to ensure that the excise tax does not undo the intended goals of the arrangement. In addition, gross-ups often were provided for reasons of equity because the excise tax punishes promoted employees in favor of those who are not promoted, newly hired employees in favor of longer-term employees, employees who do not ex- ercise options in favor of those who do and employees who elect to defer compensation in favor of those who do not. Moreover, the tax is more likely to apply to employees who receive change-in-control acceleration of performance-based compensation than it is to apply to those who receive

ISS has identified the adoption of golden parachute excise tax gross-ups in new, extended or materially modified agreements or executive change-in- control plans as a “problematic” pay practice that is likely to result in a negative recommendation on a say-on-pay vote or, where there is no say- on-pay vote or where concerns expressed by ISS on a say-on-pay vote are not addressed in the following year, a “withhold the vote” recommenda- tion for the compensation committee or even the entire board of directors. Companies that have implemented golden parachute excise tax gross-ups in preexisting agreements and plans and have determined that such gross- ups are in the best interests of the company and its shareholders need not eliminate them to avoid scrutiny by ISS, as ISS generally will make its recommendations regarding the periodic “say-on-pay” vote (but not the “golden parachute say-on-pay” vote) taking into account only agreements and plans that are new, extended or materially amended. Those compa- nies that wish to preserve such gross-ups should only amend the arrange- ments that contain the gross-ups with great care, as such amendments could de-grandfather the arrangements and result in ISS review for these purposes.37 While an extension of an existing agreement will trigger ISS review, the automatic renewal of an agreement with an “evergreen” provi- sion (itself a feature that ISS does not consider a “best practice”) generally will not be deemed an “extension” for that purpose.38

In light of ISS’s position on golden parachute excise tax gross-ups, many companies have elected to provide better-off cutbacks as such provisions provide the executives with as much of the intended benefit, as he would receive if no excise tax applied without providing a gross-up. And, while the acquiring company will lose the deduction if an executive is better off receiving all payments and paying the tax, we have not been involved in any transactions where the costs associated with the lost deduction were a significant deal issue.