The need

Any business relies on the intellectual capital of its employees and staff turnover invariably has an adverse financial consequence.

Employers who have highly valuable or key employees often find it difficult to retain their services in the face of head-hunting competitors. Replacing these employees and getting them started in the business is
not only difficult, but costly. Salary increases may provide some solution, but that alone does not guarantee the retention of key employees.

The solution

A Preferred Compensation Plan aims at retaining the services of valued employees to whom it is made available. It is agreed that they will receive a cash payment on a specific date, on condition that they remain
in the employment of the business up to that date.

Benefits to the business:

  • The cost of the plan is tax-deductible like any business expense
  • Key employees remain in employment, which leads to business efficiencies
  • Losses related to job-hopping is reduced or eliminated
  • A security cession ensures adherence to the terms of the plan on the part of the employee
  • Regular investments according to a structured plan assists accurate financial planning

Benefits to the employee:

  • A tangible benefit receivable in the near future
  • A financial incentive over and above existing benefits of employment and salary

Structure and implementation

The business identifies the employees whose services must be retained and enters into a Preferred Compensation Plan with them, which works as follows:

  • It is agreed that the employee will remain in the employment of the business up to a stipulated date.
  • In return for the commitment to this continued service, the business pays a recurring amount (usually monthly) to the employee over and above a salary or commission.
  • The Preferred Compensation payment is taxable in the hands of the employee. This holds no additional tax liability for the employee, as the preferred compensation payment is agreed on such level that it covers the tax as well.
  • The employee places the net payment after tax in a personal investment*.
  • The employee cedes the investment by way of security cession (never an outright cession in the case of an endowment, lest it becomes subject to CGT) to the business so as to guarantee adherence to the terms of the agreement.
  • Immediately before the expiry of the agreed term and if the employee adhered to the terms of the agreement, the business cancels the security cession and the investment pays out to the employee.
  • At the choice of the parties, this process may be repeated so as to ensure the continued services of the employee.

Normally the agreement provides for payment to the employee upon:

  • Adherence to the terms of the agreement; or
  • The death of the employee before maturity; or
  • The retrenchment or redundancy of the employee; or
  • The liquidation or placement under financial order of the business.

Note*: The structure of the plan could also be that the business holds the investment and makes recurring payments into it. The business then pays the maturity value to the employee as a lump-sum Preferred Compensation benefit. The employee-owned option would be followed where the marginal tax rate of the employee, based on normal remuneration structures, is lower than the top marginal tax threshold.