Top Ten Points on Variable Pay - Europe
Mar 01, 2011
Top Ten
This resource is sponsored by:
Authored by
Emanuela Nespoli, Partner, Toffoletto e Soci Italy
In recent years, the traditional salary structure has evolved to reflect modern organizational needs as well as the need for
more flexibility. In particular, the increasingly competitive business environment (especially in the current time of crisis)
has made it crucial for companies to reduce the fixed cost of labour. Introducing and implementing variable pay systems
can be a way to reach this goal. At the same time, variable pay can be an important factor to attract, retain and motivate
employees. Issues related to variable pay can be complex both from an HR and an employment law point of view. This
article (without claiming to be exhaustive) is intended to provide ten tips on this topic by identifying some definitions and
issues related to the topic in a comparative perspective. The information contained in this article has been drawn from the
findings of a study carried out by Ius Laboris (www.iuslaboris.com) on compensation and benefits and variable
remuneration involving many jurisdictions around the world.
1) What are basic and variable pay?
Throughout the jurisdictions surveyed, basic salary is defined as the fixed remuneration that an employer pays to an
employee for work performed, calculated on an annual or monthly basis depending on the provisions of the individual
employment agreement or of the collective bargaining agreement applied (if any). Variable pay (or bonuses) can
generally be intended as an addition to the basic salary, the extent and conditions of which may be set out in individual or
collective agreements, internal regulations or in bonus plans, or can even depend on the discretion of the employer.
According to the survey, it can be argued that employers, generally, have no legal obligations to pay any variable
remuneration. It is debatable whether the “mere discretion” of the employer could be a valid contractual condition for the
payment of a bonus. It seems that this would be possible in the Czech Republic and in the UK; however, such a condition
could be challenged in other jurisdictions (such as Italy or Spain) where obligations subject to a condition depending on
the mere will of a party can be considered null and void. Finally, it is worth pointing out that variable pay must not be
confused with benefits in kind (also common in many countries) which are benefits granted to employees, in the form of
goods or services: the most common are company cars, mobile phones, housing allowances, restaurant vouchers.
2) What are the different forms of variable pay?
Different forms of variable pay exist. Commonly, variable pay systems are divided into three main categories.
1) Payment-by-results schemes, where a certain proportion of the employee’s pay is linked directly to the level of
output or business outcome (for example, productivity bonuses or sales incentives).
2) Performance schemes, where employees are requested to meet specific standards or objectives not necessarily
linked to output but aimed to allow the company to achieve its overall business goals. Examples are individual or
team related rewards. Corporate performance targets such as growth in earnings per share are also common in the
UK.
3) Financial participation schemes, where employees can be entitled to share the organization performance or
profits (such as profit sharing, stock option plans, share schemes etc.).
3) How is variable pay taxed?
In many jurisdictions variable pay is taxed and subject to social security contributions in the same way as basic salary.
This is the case, for example, in Australia, Belgium, Germany, Cyprus, the Czech Republic, Estonia, France, Germany,
Norway, Poland, Portugal, Russia, Slovakia, Spain, Sweden, Switzerland, Turkey, the UK and the USA. In Italy and
Austria, under certain conditions, bonuses can be tax advantaged.
4) Is it possible or common to grant part of variable pay in stock?
As already indicated, variable pay can also take the form of stock options or other equity-based awards, which in the past
were mainly reserved for managers or executives, while in recent years have been extended to more of the workforce. In
several countries it is possible and common to have a bonus paid partly in cash and partly in stock. In the UK, this is a
requirement of the Financial Services Authority Remuneration Code which applies to financial institutions and is also
increasingly common and considered good company practice for companies outside the financial services sector. Also in
France, it is both possible and common for executives to be granted stocks (such as stock options, restricted stocks) as
part of their total compensation package; however, these are rarely included in incentive bonus schemes, as bonuses are
mainly payable in cash. In Germany, stock plans are commonly offered to managers, often in addition to other incentive
packages (including variable salary payments). There are countries, such as Brazil, where granting stocks is common,
especially in multinational companies. However, because many companies (including multinational subsidiaries) have a
limited liability structure and do not have stocks to offer, most of such incentives entail overseas stocks. In some other
countries (for example Argentina) granting stock is possible, but not common. In conclusion, it is also worth noting that
according to some legislations (this is the case, for example, in Spain, Italy and Portugal) the income deriving from the
exercise of stock options may not be subject to social security contributions, under certain conditions.
5) Why is it important to find the right balance between basic and variable salary?
Company’s should strive to set the right balance between basic and variable salary. Many companies believe that the
higher the proportion of variable salary to basic, the more the employees will be motivated to improve their performance.
However, HR practice shows that when a company provides employees with a low basic salary and a (comparatively)
higher variable salary, their performance does not necessarily increase automatically. In particular, if employees, during a
specific period of time, are not able to fulfil the objectives on which the variable remuneration is based, due to causes
beyond their control (such as market difficulties) they may feel demotivated. Furthermore, if the basic salary is very low
and the variable salary is very high, the risk is that employees could strike simply to get their bonuses paid, even when
this is not in the interest of the company. In any case, it must be considered that, in many countries, like Italy, the basic
salary may not in any case be lower than the minimum wage provided for by the law.
6) Be clear about payment conditions.
Criteria governing variable remuneration based on conditions must be simple and clear to employees, in order to avoid
misunderstandings and claims. In other words, each employee should be able, by reading his/her employment contract or
the incentive plan (if any), to make a proper calculation of his/her possible variable earnings. Additionally, it is crucial
for employees to have the chance to appreciate immediately what is expected from them in order to be paid the variable
reward. On the other hand it is in the interests of the employer to establish clear conditions for the payments and, in any
case, clarify the maximum limits.
7) Can a company unilaterally change an existing incentive plan without any prior notice to employees?
In many countries (for example, Argentina, Germany and Italy) the answer would be yes. However, though there is no
need for any prior information and consultation procedure, employees consent is nonetheless required by signing and
returning a copy of the notification of change. It may be difficult to amend a compensation arrangement to the detriment
of the employees after they have become entitled to a payment under the terms of the (previous) arrangement. Such an
issue can be addressed contractually(for example entering into a waiver and settlement agreement, as in Italy). Or as in
the UK, where many incentive plan rules provide that there can be no changes which would adversely affect existing
awards or bonuses without the consent of the majority of employees affected by those changes.
8) Can a company make receipt of a percentage of an annual bonus held back each month, conditional on the
employee not being under notice of termination at the year end?
The validity of such a clause should be assessed in each jurisdiction. In many countries (merely by way of example, UK,
USA, Italy, Argentina and Canada) it could be considered in compliance with the law. In other countries the answer could
be partially different. For example, in Brazil it would be admitted with regard to a bonus plan while not to a commission
plan, as commissions follow strict rules on the payment date. In Spain this provision would not be enforceable in a case
of unfair dismissal, if the previous entitlement were considered already an acquired right. In France, such a clause would
be considered valid only if the bonus is calculated on an annual basis but not if it is calculated monthly.
9) What is a clawback clause?
A clawback clause is a provision of an incentive plan, pursuant to which if an employee’s contract is terminated (or, in the
UK, if it subsequently turns out that performance conditions were not properly satisfied), cash and/or stock received must
be returned. The consistency of this kind of clause with the employment law should be assessed in each jurisdiction. By
way of example, in the US this clause would be considered valid so long as it is clear, not discretionary and enforceable.
Also in the UK this kind of clause could be admitted as long as it is carefully drafted and cannot be struck out by the
courts on the basis it is an unlawful penalty. It is worth noting that, in the UK, any tax and social security contributions
paid on the bonus which is clawed back cannot be reclaimed.
Similar issues could arise in Italy, where the cost of the bonus for the company is higher than the gross payment to the
employee and, therefore, much higher than the net amount received by the employee. In France, the answer to this
question varies according to whether the bonus is calculated monthly or annually. In the first case, a clawback clause
would not be in compliance with French law, as employees would have the right to the compensation as soon as the
revenue objectives for the month have been achieved. In the second case, the clause would comply with the law as long
as the incentive plan refers to this explicitly. In any case in France, if a court finds that an employee’s dismissal was
unfair, it could sentence the employer to reimburse amounts clawed back. In Germany clawback clauses are valid, but
subject to strict judgments.
10) Is it possible to provide a clause which allows a company to amend, vary or replace any of the terms of an
incentive plan at its discretion?
The answer to this question can vary case by case, depending on the jurisdiction affected and the way the incentive plan
is drafted. In general terms, such a clause can be considered valid as long as the terms of the arrangement are clear and
the employer acts in good faith. In demonstration of this, please note that in the UK there have been cases where
employees have successfully challenged the exercise of discretion by employers on the basis that it was perverse or
irrational. In any case, it is worth noting that there are countries, for example Brazil, where such a clause would not be
irrational. In any case, it is worth noting that there are countries, for example Brazil, where such a clause would not be
considered valid, as the law expressly requires the employees’ consent in writing in order to change any employment
condition.
The information in this Top Ten should not be construed as legal advice or legal opinion on specific facts and should not be considered
representative of the views of its authors, its sponsors, and/or the ACC. This Top Ten is not intended as a definitive statement on the subject
addressed. Rather, it is intended to serve as a tool providing practical advice and references for the busy in-house practitioner and other readers.
Reprinted with permission from the Association of Corporate Counsel (ACC)
2014 All Rights Reserved.
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