Tax gross up is the charitable giving of the total gross amount of pay to an employee that will be owed in taxes. This amount relives the employee any tax liability associated with possible relocation or official release from a job. Sometimes, it could be that he/she was a citizen of Norway who taxes its citizens working outside their country. This tax applied to all employed Norwegians working in countries paying taxes or not.
The costs to the employer end are higher on tax liabilities and social security contributions. This same policy was applied by companies who exercised a tax gross-up provision just before a golden parachute (A substantial financial compensation guaranteed to a company executive if they should be dismissed as a result of a merger or takeover) disclosure. In some companies, key shareholders gratefully accepted this option to secure their jobs, CIC benefits (aka ‘golden parachutes’) or enhanced compensation benefits and accelerated unvested equity.
As a result of a last-minute deal to secured lucrative deals to active management, Internal Revenue Code Section 280G was intentionally introduced. These measures prevented company takeovers since the 1980s by discouraging them from paying exorbitant “golden parachutes.” Most of the executives would value their salary at $1 per year for the five years worked preceding the CIC agreement. This gave the employer leeway to give up to three times the average taxable compensation.
With this new law, the employing company was penalized by losing tax deductions for the amount considered “excess parachute payments.” In addition, the executive paid a 20% excise tax on any excess payment penalty received. Instead of preventing and suppressing this practice, a possible loophole was discovered by the introduction of tax protection to shield the executives on any associated expunge taxes. In 2011, institutional shareholders and advisers held the view of tax gross up to be a bad pay practice. They adopted a say-on-pay rule by adequately expressing their assessment on executive pay practices. These payments were provided each year as part of the normal compensation program and transaction process.
The practice of gross-up was unadopted by many companies. However, in the years 2012 to 2017 many companies exercised the golden parachute option payable disclosures to NEOs ranging from $6M to $258M. These transaction values when equated as a percentage ranging from 0.1% – 8.1% of the total golden parachute payments. The valued excise tax gross-up was substantial ranging from $900 000 to $32M. As a percentage, the total golden parachute payments ranged from 0.03% to 1.2% of the total golden parachute tax payments. These golden parachute payments happen to be offered last minute by many companies with implementation rationale being ungiven.
These companies were protecting their business interests. Among the limited number of companies that offered their compelling rationale, three sufficient justifications were offered. First, special arrangements were made for key executives to remain during the transition period following the CIC.
Secondly, the excised tax gross-up was considered for entering a restrictive covenant agreement by executives. These executives would be subject to aggressive non-competition and non-solicitation provisions for a specified period after the termination of the agreement.
Thirdly, the value of the equity acceleration represented the overwhelming majority of the golden parachute payment which was driven by the deal price negotiated by the executive. The most superior interest of the principal shareholders and the 280G excise tax imposed on executives was corrective compared to the value delivered to the shareholders. Therefore, the decisions to exercise tax gross up was weighed whether the benefits to shareholders will ultimately outweigh their exorbitant costs as part of their fiduciary oversight.