Deferred Compensation Trusts – March 2000

Deferred Compensation Trusts – March 2000

There are a number of deferred compensation arrangements that have been developed to help senior executives to defer or avoid both national and local taxes on their remuneration packages whilst working at home and abroad.

The term “deferred compensation” may be applied to any payment for services not made at the time the services were rendered. These arrangements typically rely upon the trustees of a Jersey discretionary trust to hold the deferred remuneration assets. As a professional trust company, Volaw Trust Company is regularly instructed to establish and administer such trusts.

This briefing note explains some of the benefits that might be gained from establishing deferred compensation arrangements using Jersey trusts; it also explains how Volaw Trust Company is able to help in establishing such trusts and in providing trustee services.

WHO MIGHT BENEFIT FROM THESE PACKAGES?

It is customary for an employer to reflect regional variations in the cost of living, housing and income tax in the remuneration packages of its expatriate executives. In addition, such executives habitually receive bonus awards intended to compensate them for the inconvenience of living abroad. The income tax associated with the remuneration is frequently a significant part of the assignment cost. Therefore, any reduction in this tax cost is desirable, especially when the benefit accrues to both employer and employee. It is commonplace for employees to view their bonus awards as a source of savings. Accordingly, if the employer offers to provide an attractive savings vehicle, whilst reducing the tax liability, it is possible to improve the expatriate remuneration package whilst at the same time achieving significant reductions in the cost of assigning the executive abroad.

WHEN WILL TAX BE PAYABLE?

Once an employer has established a deferred compensation plan for the benefit of its expatriate employees, the employees do not become liable to tax (either in their home or in their host country) on the income contributions that the employer makes to the plan, until such time as they receive distributions from the plan. Such distributions will be taxable in the year that they are paid. Hence, tax is deferred until the employee receives the distribution. Until distributed to the employee, the trust fund is invested and, because the contributions made to the trust are without deduction of tax, the investment returns are likely to be substantially greater notwithstanding the eventual charge to tax. This provides an additional benefit to the employee.

WHAT ARE THE POSSIBLE ADVANTAGES TO THE EMPLOYER?

From an employer’s perspective, the establishment of a deferred compensation plan may lead to the following possible advantages:

  • The reduction or eradication of the host country’s social security and income tax levies;
  • The reduction of tax equalisation payments and the overall cost of all foreign assignees participating in the plan;
  • The deferral of cash outlay. The employer may offer attractive interest rates to the employee and thereby retain cash liquidity for longer;
  • The provision of a major incentive to those employees assigned to join the overseas-based work force;
  • The motivation of existing overseas assignees to remain diligent and loyal to their foreign assignments.

WHAT ARE THE POSSIBLE ADVANTAGES TO THE EMPLOYEE?

From an employee’s perspective, the main criteria influencing his decision to participate in the deferred compensation plan will be:

The deferral of taxation on his remuneration/bonus payments until such time as funds are actually distributed to him, at which point income tax and not capital gains nor gift taxes will be applied;