American Benefits Council: Deferred Compensation of Expatriate International Employees June 8, 2010

1. American Benefits Council: Deferred Compensation of Expatriate (International) Employees June 8, 2010  Miller & Chevalier

2. Deferred Compensation: Section 457A Background: Section 457A was enacted on October 3, 2008, in the tax section of the Emergency Economic Stabilization Act of 2008 The section was intended to limit deferrals of compensation by U.S. individuals employed by “tax indifferent” entities (such as certain foreign corporations in “tax haven” jurisdictions). Lack of tax tension exists in this situation Original legislative concern was hedge fund employees, but statute as enacted impacts all industries

3. Executive Compensation – Section 457A Summary of Section 457A Under new section 457A, deferred amounts under plan of a nonqualified entity are includible in gross income of US-taxpayer employee as soon as there is no substantial risk of forfeiture, even if plan meets section 409A; special rule where amount not determinable at vest Effective for deferred compensation attributable to services performed after December 31, 2008 No permanent grandfather of pre-2009 amounts Guidance issued (as Q’s and A’s) in Notice 2009-8

4. Executive Compensation – Section 457A Key Elements of Compensation Subject to Section 457A: Deferred Compensation The compensation is deferred compensation generally using a definition like that in section 409A The compensation is not exempt as a short-term deferral – using rules slightly different than section 409A (substantial risk of forfeiture (SROF) is defined more narrowly, but get 12 months to pay) The compensation is not exempt equity compensation – again using rules slightly different than section 409A (cash settled SARs are subject to 457A)

5. Executive Compensation – Section 457A Key Elements of Compensation Subject to Section 457A (continued): Deferred Compensation of a Nonqualified Entity The compensation is under plan of a nonqualified entity (NQE) if under US tax standards, the NQE would be entitled to deduct the compensation. Notice 2009-8, Q&A 14

6. Executive Compensation – Section 457A Key Elements of Compensation Subject to Section 457A (continued): Deferred Compensation of a Nonqualified Entity Very generally, a “nonqualified entity” or NQE is A foreign corporation or US or foreign partnership The income of which is not subject to significant US or foreign income tax

7. Executive Compensation – Section 457A Notice 2009-8 provides Q&A-style guidance for determining “nonqualified entity” status more specifically Generally tests on two bases: Whether the entity’s income is subject to a comprehensive foreign income tax (i.e., an examination of the foreign tax system and how it applies to the entity) Whether the entity is in fact liable for comprehensive income tax on substantially all of its income (i.e., an examination of the entity’s foreign income tax return)

8. Executive Compensation – Section 457A Notice 2009-8 provides Q&A-style guidance for determining “nonqualified entity” status, which generally tests on two bases: Whether the entity’s income is subject to a “comprehensive foreign income tax” Either eligible for the benefits of a “comprehensive income tax treaty” between the U.S. and its residence country Or, the foreign corporation is resident in a country that has a comprehensive income tax But in either case, the entity is non-qualified if subject to a tax regime “materially more favorable” than the generally applicable corporate tax regime

9. Executive Compensation – Section 457A Open Issues What is a “comprehensive foreign income tax”? “Angel list” possible? Carve out U.S. possessions? What does “materially more favorable” mean? Which CFIT counts for the substantially all test? How to account for reverse hybrid income (not taxed in the R/H’s country but possibly taxed at the owner level)? How to account for checked branch income (possibly taxed at the DE level but not taxed at the owner level)?

10. §457A Nonqualified Entity

11. Executive Compensation – Section 457A Examples where Sec. 457A Applies: Example 1: In Year 1, US citizen working in US is granted RSUs that vest December 31, Year 3 and are payable by March 15, Year 4. However, units “continue to vest” on retirement, even though payable by March 14, Year 4, and the employee becomes retirement eligible in Year 2. Employee is transferred to a Puerto Rican affiliate in Year 1. Section 457A applies and the employee is taxable in Year 2. Example 2: Same facts as above example, but units are PSUs. Section 457A would apply, but taxation would not occur until December 31, Year 3, at which time there would be penalty taxes.

12. Executive Compensation – Section 457A Examples where Sec. 457A Applies: Example 3: Employee who is transferred to a UK affiliate that is located in the Scottish Development Zone continues to accrue benefits under the SERP. Employee is fully vested. The affiliate is a NQE under section 457A. Incremental increase in SERP benefits due to service performed for NQE is taxable currently under section 457A.

13. Executive Compensation – Section 457A Common 457A Myths Debunked Expats in US plans can be impacted Seconding arrangements do not necessarily work to protect employees from section 457A The fact that the foreign entity is in a treaty country does not necessarily protect employees from section 457A Puerto Rico and other U.S. possessions are “foreign” for these purposes

14. Executive Compensation – Section 457A Consequences if Section 457A Applies: Employee generally is taxed at vesting. Employer likely is required to report the income at vesting; withholding obligation is unclear because there is no payment of wages then If amount of compensation is not then determinable (e.g., because the compensation is performance-based), the tax under section 457A is when the compensation is determinable, but it is at that time subject to 409A-like penalties, a 20% penalty tax and an interest charge tax Deduction would seem to follow income to employee

15. Executive Compensation – Section 457A Why should sponsors care? Section 457A is effective now Information reporting requirement Compliance requires a team of international benefits and tax personnel Expat agreements generally provide for tax equalization, so the company may bear the ultimate burden of the tax acceleration Action item in 2011 re: accelerating grandfathered amounts without violating section 409A

16. Executive Compensation – Section 457A What to do? The government has been requesting comments on Notice 2009-8 This appears to be an area where comments will be taken very seriously

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