October 2012 Quarterly review People Focus - Ernst & Young

People Focus

October 2012

Quarterly review

Introduction Dear Readers,

In this issue:

We are pleased to present the autumn edition of People Focus. Introduction 1 Vera Yelutina Global Mobility: Tax Equalization Programs Vladimir Fesenko

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A house in the heart of the Kingdom 6 Maria Detkina Tax uncertainty… do you have a Plan B? Vladimir Fesenko Housing rental for an employee and income tax Lyudmila Sapronova Labor market: focus on efficiency Olga Gracheva

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As employers continue to gradually make their employment populations more mobile, increasingly complicated assignments and overseas working patterns are causing increasing concerns for all parties involved. Moving between multiple countries or working in multiple countries can expose both individuals and their employers to a host of tax related complications. Employers require a tax policy that ensures compliance with both home and host country tax authorities and limits financial exposures for the company, while ensuring that the globally mobile employees are treated fairly and are satisfied with the cover that the policy provides for them. Employees will wish to ensure that they are not left worse-off financially as a result of their assignment. They also need to remain compliant in both home and host locations. The options open to employers who send their employees on overseas assignments are more varied than may be initially believed, and it is important that clients are aware of all of the options when they formulate their assignment tax policies. This edition explores the different options available to employers in more depth. As part of their relocation packages, many assignees are now provided with accommodation by their employer, and the taxation of this benefit has become a hot topic for our Russian clients. Differing interpretations of the tax code from the courts and the Finance Ministry have caused confusion as to how the provision of housing should be treated for Russian income tax purposes. This disagreement effects both the provision of housing to Russian employees and the provision of housing to foreigners, and is explored further. On the subject of housing, recent changes to tax legislation in the UK may be relevant for clients interested in purchasing UK property. The current British government has made the issue of tax avoidance a main economic focal point, and is looking at more and more new ways in which it can limit tax avoidance and recoup as much tax as possible for the UK treasury.

As part of a range of measures announced along with the last UK budget, special rates of UK stamp duty have been imposed that may affect our clients as they look to invest in UK property. The implications of these changes are explained in more depth within this edition.

the government will look to increase taxes, but the political situation and scheduled federal spending cuts mean that the position is not yet clear. This edition looks at what the potential changes may mean for our clients.

And finally, as we look further at overseas tax regimes, the effects that the upcoming US presidential elections are having on the US tax regime are investigated further, as the US, like the UK, seeks to maximize its’ tax revenues while continuing to keep its’ economy growing. The expectation is that

As the year draws into its second half, we have looked at the trends in the labor market, specifically in the area of compensation and benefits. The majority of employers have indicated their intention to continue providing across the board pay raises, with some companies focusing on performance driven increases.

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People Focus October 2012

We hope that you will find the articles in this issue useful, as we push into the final quarter of 2012.

Global Mobility: Tax Equalization Programs

As Russian companies increasingly expand abroad, global mobility issues, including the tax neutrality of employees sent abroad, have moved up on their agenda. Tax neutrality means that assignees pay approximately the same income tax as they would if they had not been sent abroad. Employees going on long term international assignments usually receive significantly more generous income, intended to cover, among other things, allowances for work abroad, relocation expenses incurred by employees and their families, cost of living, car rental and mobile phone service. The substantial increase in assignees’ income as well as differences between personal income tax rates in the home and the host country may result in a substantially greater worldwide tax burden on employees. In order to minimize the extra tax burden on employees sent on international assignments, many companies have introduced tax equalization or tax protection programs and reimburse such employees for additional taxes in both countries. Tax equalization, however, is not regulated by law. Generally, companies include special provisions regarding tax equalization in their internal policies governing the employer-employee relationship.In practice, employers calculate and withhold tax (“hypothetical tax”) that assignees would have paid on their income if they had not

been sent abroad. Hypothetical tax is calculated before assignments, based on the amount of income earned by assignees, irrespective of their place of work, which usually comprises salary and bonuses. For purposes of tax equalization, employers may calculate hypothetical tax for employees using the rates of the home country, host country, the country where the employer’s head office is located (e.g. Russia) and the country of an employee’s permanent residence or citizenship. This means that assignees pay hypothetical tax directly to their employer instead of paying it to the budgets of home and host countries. The employer, in turn, uses these funds to pay the assignees’ tax liabilities in their home and host countries. Employers often calculate hypothetical tax based on assignees’ salaries and bonuses as well as other compulsory payments unrelated to their assignments. Taxes on additional compensation and special assignment-related payments, such as accommodation, car rent and mobile phone services, are normally paid by employers through withholding at source. In tax equalization policies, the burden of paying tax on other types of income, capital gains, personal income or income earned by a spouse, is usually placed on assignees. At the end of the tax year, hypothetical tax withheld from employees during the year is compared with the final tax liability based


on their final income. As a result of this reconciliation, employers pay the difference to employees (if the final hypothetical tax liability is lower than the amount withheld), or employees pay their employers (if the final hypothetical tax liability is higher than the amount withheld). Employers must fully reimburse any actual tax liabilities incurred by assignees in the home and/or host country. In current practice, employers often introduce the following tax reimbursement programs: tax equalization, tax protection and gross-up.

Tax equalization Under a tax equalization policy, employees sent on international assignments pay the estimated hypothetical tax to their employers on a regular basis during the year as if they had not been sent abroad, while the employers pay all of the assignees’ actual home- and host-country tax liabilities. Before an assignment, the employer estimates the hypothetical tax, which is then withheld at source in each period (e.g., on a monthly basis). The employee’s homeand host-country tax returns are prepared. Either the employee or the employer pays the actual tax liabilities, if applicable, in both countries. At the end of the year, the employer calculates the employee’s final hypothetical tax liability and, if applicable, reimburses what the employee has actually

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paid. The final hypothetical tax liability is compared to the hypothetical tax withheld at source during the tax period. If the final hypothetical tax liability exceeds the amount withheld, the employee pays the difference to the company, and vice versa. If there are any significant changes that could impact employees’ tax liabilities (e.g., a significant change in income, tax status or family size), employers may update their hypothetical tax calculation during the course of an assignment.

Among the disadvantages of tax equalization is complexity due to the need to calculate hypothetical tax on a regular basis and explain the policy to employees. There may also be an issue of confidentiality, since assignees have to disclose full information about their personal income if the employer assumes responsibility for compensating their actual tax liabilities.

Tax protection Under a tax protection program, employees sent on international assignments pay all actual home- and host-country tax liabilities themselves either through withholding or by filing tax returns. Based on the year-end results, the employer calculates the assignee’s hypothetical tax – an estimate of the stay-at-home tax the assignee would have paid had he or she not been sent abroad – and determines the difference between the estimated hypothetical tax and the employee’s actual tax liabilities. If the hypothetical tax liability is lower than the actual tax amount paid, the employer pays the assignee the difference. If the actual tax amount paid is lower than the hypothetical tax liability, the employee retains the difference.

One of the advantages of tax equalization is the neutrality of employees in terms of selecting an assignment location and also their financial stability: they will receive equal treatment in all tax jurisdictions, while tax liabilities to their employers will be the same as they would have been in the home country had they not gone on assignment, meaning that employees will receive an after-tax income that is neither higher nor lower. In addition, employers may benefit from tax equalization if assignees are sent to a country with a tax rate lower than that used to calculate and withhold hypothetical tax, as the difference between hypothetical tax and the actual host-country tax will constitute income for employers paying the actual taxes. But when an employer sends employees to both higher- and lower-tax jurisdictions, the assignments overall balance out.

Among the advantages of tax protection is that it is simple to administer. Employers can easily pay employees the amount by which actual tax exceeds hypothetical tax

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based on the year-end results without having to deal with this issue during the year. However, tax protection can be more advantageous to employees than employers: if taxes paid in the host country are lower than employees’ estimated stayat-home tax, the employees owe only the actual tax liability. A disadvantage is that employees have to pay all actual tax liabilities before the final settlement with their employer, based on the results of the reporting period. This means that the employees’ guaranteed income can vary from month to month. Tax protection, however, may require employers to pay employees’ negative balance at the end of the tax period. A further disadvantage is that employers have to make a substantial expense provision for reimbursing excess taxes to employees after end of the tax period.

Gross-up In the case of tax gross-up, employers estimate assignees’ total actual home- and host-country tax liabilities at the beginning of the year and include this amount in assignees’ monthly payroll to ensure that they receive a guaranteed after-tax income. Simplicity of administration is the main advantage of a gross-up. In addition, there is no negative financial burden on employees, because companies

compensate all taxes on a monthly basis by including the actual host-country tax liabilities in the reimbursement package. The lack of mechanisms for estimating employees’ actual tax liabilities is a disadvantage of the policy. Tax reimbursement is normally calculated based on the highest tax rate in place. Moreover, the difference between employees’ actual tax liability and the amount they are given for its payment is not returned to the employer, resulting in additional costs for the company. *** Tax reimbursement programs for international assignees are becoming increasingly popular among Russian companies that are going international.

Tax equalization is the most common program worldwide. It is normally the best choice for multinational corporations whose international assignments are widely dispersed geographically. Tax protection is commonly used by companies with a narrower range of assignment locations. When an employee needs to be sent urgently on an international assignment and time is of the essence, the company may choose the gross-up method as the easiest to use. In any event, companies that strive to develop and maintain an efficient international assignment process should think about formulating a uniform policy that will apply to all assignees, regardless of their assignment location.

The choice of a tax policy depends on company’s priorities. If a balanced approach is what matters most, a tax equalization program is more expedient. If simplicity of administration is higher on the agenda, the company should consider opting for a gross-up policy.


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A house in the heart of the Kingdom

Are you, or your family, relocating to the United Kingdom? It is time to buy a house there. The advantages of keeping a house in the UK are indisputable, though there are some issues in the English “fairy tale” that are worth thinking about. Maria Detkina tells us how to become a British homeowner with minimal tax burden. The 2012 Chancellor’s Budget contained a number of announcements that will affect the ownership of UK residential properties. Specifically, the proposals are focused on non-UK corporate or other non-natural structures holding UK residential property, known as “envelopes”, which are frequently used by owners of expensive property for optimizing high UK taxes by means of indirect ownership, e.g., offshore companies and trusts. Proposals related to the increase of Stamp duty land tax (SDLT) on the acquisition of expensive property were extensively discussed this spring. However, this is only a part of the proposed package of measures aimed at tackling tax avoidance which will be gradually introduced in 20122013. The following three steps are foreseen by the package: • F irstly, introduction of a special SDLT rate of 15% which will apply to the acquisition of residential property by ‘non-natural persons’ • S econdly, introduction of an annual SDLT charge on the value of the above mentioned property held by the same group of ‘non-natural persons’

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• T hirdly, extension of the capital gains tax to tax UK nonresident ‘non-natural persons’ on disposal. It should be mentioned that the above proposals refer to UK residential property above £2 million. We will clarify below some specific and important provisions of the coming changes.

SDLT You may remember that SDLT is a one-time transaction tax, payable in the UK by the buyer, on the purchase of land and/or property or the acquisition of an interest in land or property. On 21 March 2012 a new SDLT rate of 7% was introduced. This rate is applicable to residential properties valued at more than £2 million. Herewith, in case the purchaser of such residential dwellings is one of a specified class of non-natural persons, a special SDLT rate of 15% will apply. And who is a ‘non-natural person’ for the purposes of this SDLT charge? The term stands for companies (which are defined as bodies corporate), collective investment schemes and partnerships where at least one of the partners is a company. The 15% rate will only affect property that is acquired by ‘non-natural persons’ from 21 March 2012 and not properties already held in these vehicles.


Annual charge While the 15% SDLT rate is an accomplished fact, the annual SDLT charge, which is deemed to apply to expensive residential property above £2 million owned by certain ‘non-natural persons’ from April 2013, is the consultation document yet. The public consultations started in May and lasted till 23 August 2012. The annual charge is planned to be in the range of 0.3% to 0.75% of the property value with properties placed in bands of increasing value (but initially capped to a maximum of £140K per annum). Specifically, for 2013/14 accounting year the proposed annual charge would be in the range of £15K-£140K. The charge is expected to be indexed to the Consumer Price Index. However, the property values, and hence the property values bands themselves, do not appear to be indexed in any way. It will be the responsibility of the property owners to obtain valuation reports or selfassess their property’s value in time for the introduction of the charge, i.e., by 1 April 2013. Properties must be re-valued every five years for the purpose of the charge (the first revaluation will take place not earlier than 1 April 2017). There is currently no indication that there will be any opportunity to revalue before this date, for example to reflect a fall in property values.

Special attention should be paid by the owners of residential property with a value close to £2 million. In case HMRC concludes that the property is worth more than the established threshold of £2 million, and its owner has not taken proper care about its correct valuation or intentionally (or due to negligence) undervalued it, which resulted in non-payment of annual charge, penalties will apply.

Capital gains tax charge An offshore company in a property holding structure was allowed to avoid Capital Gains Tax until recent times, even in respect of selling UK property (though anti-avoidance legislation treats gains on disposals by nonUK resident companies and trusts as accruing to UK resident individuals in certain circumstances). But the legislative provisions that have left UK non-residents outside the scope of CGT will soon fall into oblivion, at least for ‘non-natural persons’. The new proposals extend the capital gains tax regime to tax gains on UK residential properties where such gains are not currently taxed (with certain exception for non-UK resident companies that are currently liable to corporation tax). In order to be consistent with the annual charge, it is intended that the extension of CGT will only apply where the amount or value of

the consideration for the disposal exceeds £2 million. However the definition of ‘nonnatural person’ for the purpose of the extension of CGT will likely be extended. Specifically, it could be extended to include trustees, personal representatives and entities from other jurisdictions, e.g., foundations. The intention is that the new regime will apply to all disposals of UK residential property, including the grant of an option over such property. There will also be a charge on any gains that accrue on the disposal of assets (of whatever form) that derive their value from residential property. This will include, for example, shares or other interests in a property holding company, where more than 50% of the value of the asset is derived from UK residential property. The CGT rates are still uncertain (they will probably be in the range of 20-30%), whereas there is an important issue which should be taken into consideration. Specifically, it is the full amount of the gain on the asset since acquisition which will be taxed, not just the gain since April 2013 (when the provisions will come into force). The delayed introduction of the new rules may represent a planning opportunity for some structures to rebase ahead of the new charge.


Inheritance tax Summing up the above, it is worth thinking about inheritance tax, which in the UK may reach up to 40%. Traditional structures used by owners up to now have provided a significant level of inheritance tax protection. These traditional structures now face new charges on acquisition and disposal and indirect ownership. A decision on which structure to choose requires a trade-off between inheritance tax and new charges. And this is the time for homeowners to decide what the key tax is that they wish to optimize – in a new reality, one should learn the ropes and dedicate more time to proper tax planning and structuring. The recent legislative proposals discussed above do not foresee any changes in respect of the UK inheritance tax. Herewith, as the attention of HMRC is getting closer to taxation of wealthy individuals and their assets, such possibility should not be excluded in the foreseeable future. It is clear that the UK tax regime will provide challenges in the months ahead

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Tax uncertainty… do you have a Plan B?

Starting from 2013 Bush tax cuts enacted under President Bush in 2001 and 2003 are scheduled to expire. In some respects, 2012 is reminiscent of 2010, when the Bush tax relief was first set to expire. However, at that time the US economy had just come over the crisis and US legislators did not dare to change the tax policy dramatically and simply decided to extend the Bush tax relief for all income groups through 2012. This year is a year of president’s election and taking into account a slightly growing US economy and a moderate unemployment statistics, nothing seems to interfere so long awaiting abolishment of tax reliefs. In 2013, the tax cuts enacted under President Bush in 2001 and 2003 are scheduled to expire. In some respects, 2012 is reminiscent of 2010, when the Bush tax cuts were first set to expire. However, at that time the unemployment

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rate in the US was very high, and US legislators did not dare to change tax policy dramatically. In the end, they simply extended the Bush tax cuts for all income groups through 2012. This year is an election year and, taking into account the continued struggles of the US economy and the improving (but still high) unemployment rate, the future direction of American tax policy is very uncertain. Scheduled automatic federal spending cuts further complicate the short-term outlook. Beginning in January 2013, $1.2 trillion of automatic spending cuts (“sequestration”), mandated by the Budget Control Act of 2011, are scheduled to occur. Many policymakers, including members of the Obama Administration, would like to find alternatives to sequestration, but options that appeal to both political parties are limited.


The next few months provide a critical opportunity for taxpayers to weigh their options and determine their preferred course of action. This process should take into consideration the political, fiscal and legislative environment that could determine the fate of future tax policy.

Proposed changes The 2013 tax year may bring significant changes to American tax policy, including scheduled rate hikes. These changes will affect the income tax, long-term capital gains tax and qualified dividends tax. High income taxpayers will likely also be subject to an additional Medicare tax increase.

The scheduled increases in taxes are shown in the figure below. Description

Current rates

Scheduled rates for 2013

Other additions

Individual income tax rates

10%; 25%; 28%; 33%; 35%

%; 28%; 31%; 36%; 39.6%

Individuals with income over $250,000 (joint) or $200,000 (individual) will be subject to the following Medicare tax increases: • 0.9% on wages (on amounts exceeding threshold) and • 3.8% on the lesser of: —N et investment income (e.g., interest, dividends, capital gains) or —E xcess of modified AGI on amounts over the $250,000/$200,000 threshold

Reinstate personal exemption phase-out (PEP) and Pease limitation on itemized deductions

Qualified dividends

0%; 15%

Long-term capital gains 0%; 15%

Estate/gift tax/ generation-skipping transfer tax

35% top rate; $5.12 million exemption

Individual income tax rate, with top rate of 39.6%

3.8% Medicare tax on qualified dividends of taxpayers who meet the income thresholds could also apply

15%; 20%

3.8% Medicare tax on long-term capital gains of taxpayers who meet the income thresholds could also apply

55% top rate; $1 million exemption

Obviously, the uncertainty surrounding future tax policy has led taxpayers to reconsider their investment guidelines.


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What to expect? While policymakers are actively debating the way forward, including a compromise to avoid sequestration, the following potential developments may be forecasted at this time: • C urrent tax permanently extended for all Congress could extend the Bush tax cuts permanently at all income levels. President Obama has stated his preference to let the cuts expire for income over $250,000. Gov. Mitt Romney has suggested making the Bush tax cuts permanent and cutting an additional 20% off marginal rates. Romney’s plan would make the 15% rate on capital gains and dividends permanent and eliminate the tax altogether on capital gains, dividends and interest for individuals with adjusted gross income of less than $200,000. Gov. Romney insists that any tax changes he implements would be revenue neutral, something he would achieve through closing tax loopholes and limiting/ eliminating some deductions aimed at wealthy individuals.

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• Tax relief permanently extended for some The Obama Administration has expressed a preference for limiting any extension of the Bush-era rates to income of $250,000 or less, while allowing taxes on income over $250,000 to revert back to the Clinton-era rates. Some policymakers have proposed raising that threshold to $1 million. • T ax relief extended temporarily Congress could pass a temporary extension of the Bush tax cuts. The extension could either be acrossthe-board or limited to income below a certain threshold. • Piecemeal approach Lawmakers could also tackle each subset of tax issues separately, allowing some to expire while extending others. This approach may be used as part of a larger political compromise. • Do nothing Congress could also defer entirely to the incoming 2013 Congress, allowing all of the provisions to expire.


Planning decisions hinge on a taxpayer’s specific circumstances and on which course of congressional action seems most likely. Taxpayers should consider modeling out the various possibilities to help develop a course of action.

Some points to think over High-income taxpayers may face increases in their income tax rate, a higher tax rate on qualified dividends and capital gains and a new Medicare tax next year. As such, reviewing portfolio allocations now could be a helpful exercise. With tax rates on capital gains scheduled to rise from 15% to 20% next year, plus the additional 3.8% Medicare tax, accelerating capital gains into 2012 could merit consideration. Other possibilities include shifting from taxable to tax-exempt investments, adjusting taxable and tax-deferred investment portfolios and accelerating the exercise of stock options. Converting from a traditional IRA to a Roth IRA and paying the tax on the conversion in 2012 may also be prudent for taxpayers who believe tax rates are likely to rise in the future. Taxpayers should weigh carefully the pros and cons of each of these options.

From an estate planning perspective, for the rest of 2012 the gift and generationskipping transfer (GST) tax exemptions are $5.12 million and the top rate on transfers above those amounts is 35%. Absent congressional action, in 2013 those exemptions will drop to $1 million (the GST exemption is indexed for inflation) and the top rate will climb to 55%. Using the exemptions now can remove appreciation in an asset’s value from the taxable estate for federal estate tax purposes. But, taxpayers also need to take into account issues beyond tax planning, such as the potential impact of scheduled and proposed income tax changes on their own cash flow and financial security. As a practical matter, the wisest course is to take any actions after the election to determine whether a wealth transfer would be prudent. However, those who wish to be more proactive should reconsider how and how much to give away before the end of the year.

It’s time to work out a Plan B Now is the time to think about short- and long-term financial and tax planning. Much has changed since the last time tax rates were set to rise, and taxpayers may need to revisit planning options in the context of this new tax landscape. While there are many tax planning options available, there is also significant uncertainty about what tax rates will look like after 2012. While awaiting the final results for the 2013 tax rates, to be on the safe side it is best to form a Plan B. By planning ahead, modeling various scenarios, and understanding the pros and cons of their options, taxpayers will be best positioned to make sound financial decisions heading into 2013.


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Housing rental for an employee and income tax

To hire a person for work at a locality where he/she does not reside, employers often pay for housing rent, especially when this concerns foreign nationals or executives. For the sake of convenience, employers enter into rental agreements themselves and transfer the rental fee directly to the landlord. On the one hand, this is quite logical, because the employer thereby compensates for the additional expenses which an employee incurs when working at a locality where he/she does not reside. Therefore, such payment can hardly be regarded as an employee’s income. On the other hand, labor legislation obliges an employer to pay for an employee’s stay at another locality only when he/she is sent on a business trip there. Therefore, under the law, an employer is not required to provide free housing when transferring an employee to another locality where the employee has no place of his/her own. In this respect, payment for rent can be regarded as additional income. Today, opinion is divided on the taxation of this payment, since the issue of rental payment as an integral part of a salary or as compensation is yet to be resolved. The

clarifications made by the government authorities frequently contradict judicial practice. In their rulings, the courts often indicate that it is in the employer’s interest to pay for housing for an employee who moved to another locality to work, and that such payment has nothing in common with the payroll. Article 164 of the Russian Labor Code says that this payment should be deemed compensatory, since it is compensation for the expenses incurred when an employee performs official duties1. Moreover, the courts refer to Article 169 of the Labor Code, which regulates reimbursement for the employees’ expenses when they move to another locality to work, and according to which the payment for their stay may be viewed as part and parcel of the compensation for their transfer2. As for foreign employees, the courts have one more argument: they refer to legislation whereby the host must provide housing for foreign nationals3.

The Finance Ministry holds an opposite view. In its letters, the Ministry explains that rental payment should be deemed income received in kind in line with Article 211 of the Tax Code. In short, the Ministry does not regard rental payment as compensation and, accordingly, draws the conclusion that such payment is subject to personal income tax4. In addition, the Finance Ministry sees no grounds for tax avoidance even when foreign nationals are concerned. According to the Ministry, the employer is bound by law to provide a foreign national with housing, but not to pay for it4. When current legislation and its interpretation lack clarity, the approach to the taxation of rental payment largely depends on the employer’s conservative stand. If an employer seeks to avoid disputes with the tax authorities (and the ensuing court proceedings), he/she will most probably regard rental payment as income in kind and subject to personal income tax.

Hence, according to the courts, rental payment should not be subject to personal income tax as compensatory payment in line with Article 217.3 of the Tax Code.

1

Ruling No. F09-3304/12 of the Federal Arbitration Court of the Urals District of 8 June 2012.

2

Ruling No. KA-A40/1449-11 of the Federal Arbitration Court of the Moscow District of 21 March 2011.

3

Federal Law No. 115-FZ of 25 July 2002 “Concerning the Legal Status of Foreign Citizens in the Russian Federation”, Statute on the Provision of Material, Medical and Housing Guarantees to Foreign Citizens and Stateless Persons for the Period of Their Stay in the Russian Federation (approved by Decree No. 167 of the Government of the Russian Federation of 24 March 2003).

4

Letter No. 03-04-06/8-272 of the Ministry of Finance of the Russian Federation of 7 September 2012.

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Letter No. 03-03-06/1/255 of the Ministry of Finance of the Russian Federation of 18 May 2012.

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Labor market: focus on efficiency

The situation in the Russian economy, and as a consequence on the labor market, at the end of 2011 could be characterized as the “calm before the storm”. More and more often the second wave of the financial crisis was forecasted with expected consequences being economic downturn, an increase in unemployment and stagnation on the labor market. However, the first half of 2012 was quite calm. The growth of GDP in 2011 was 4.3%, which corresponds with last year’s growth. The stability is mostly supported by high energy prices: despite the uncertain economic outlook, the price of Brent Crude held strong at US$100-110 per barrel all throughout 2011 and even exceeded the US$120 per barrel mark in the first quarter of 2012. To compare, a Brent barrel in 2010 averaged US$70-80. In spite of the slowdown in the manufacturing sector and the decrease in the Index of Industrial Production, economic growth was also supported by the recovery in the agricultural sector, which recorded a record harvest. Among positive trends is an all-time low inflation rate in Russia. A figure of 6.1% was recorded in 2011, which is the lowest for the last 20 years. In 2011, positive trends were also noted on the labor market. As a result of the gradual decrease of the unemployment rate from 2010-2011, the employment rate has almost reached a precrisis level, with the coefficient of

manpower balance, calculated as the ratio of hired employees to dismissed employees, almost equal to one during 2011. A significant contribution to the economy’s growth in 2011 was made by an increase in human consumption, which was supported by a decrease in inflation and unemployment rates and an increase in consumer confidence stemming from increased salaries. According to the Federal State Statistics Service («Rosstat»), the consumer confidence index almost doubled: growing from -13 to -7 in 2011. Analysts are cautious in their forecasts in terms of the ongoing development of the Russian economy. Economic instability negatively influences the predictability of consumption of energy resources. Moreover, due to the fact that supply and demand on this market haven’t determined the consumption in full for a long time now, as they don’t take into account the behavior of speculators, the forecasting of future oil prices is being impeded. In this regard, the future of the Russian economy is quite uncertain. At present, Russian economists stick to the most conservative forecasts and expect a slight economic slowdown in 2012 to 3.8%. In the long term, economic growth at the end of 2013 is predicted to be at the same level as in 2012, with growth increasing at 4.0-4.2% every year until at least 2017.


Forecasts for the inflation rate going forward are also optimistic: a gradual decrease from the current 6% to 5% by 2017 is anticipated. Considering the above mentioned conservative and optimistic forecasts, the current situation on the labor market can be characterized as relatively stable. With the economy growing in Russia, employers started to increase their investment in personnel in late 2011 and the beginning of 2012. At the same time, they approached this investment carefully and cautiously, avoiding significant expenses and choosing those which guarantee return on invested money and time. The main indicators of the labor market, Wage Price Index (WPI) and attrition rate, have reached their expected levels. Based on the EY Labor market survey, salary growth from May 2011 to April 2012 averaged 8%-10%, which fully met last year’s budget parameters. It appears that the salary changes reflect the trajectory of the Russian economy’s growth. Employers continue to raise their employees’ salaries at a level at least exceeding inflation rate. It’s worth mentioning that more than half of survey participants (65%) take into account the inflation rate in establishing the percentage of salary review.

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In addition, the analysis of the actual data on the dynamics of salary levels for certain jobs showed much higher salary growth for some jobs (up to 40%) and almost zero changes for others. This indicates that the employers use a selective approach to the salary review: at present, companies prefer investing in efficient employees who demonstrate high performance. More than 85% of survey participants indicated that performance evaluation results are the main ground for salary review. In terms of salary growth for next year, employers’ plans are quite conservative. Due to the modest forecasts on economic growth, as well as the relatively low inflation rate that is expected, companies put 8%-9% salary increase in their budget plans for the next year. However, distribution of additional payroll among jobs will likely be uneven, the trend of individual approaches to salary review, relying on performance results, will remain. Comparing the inflation rate and pace of salary growth, it appears that the growth of employee income is slight and the situation will not change next year. At the same time, in most cases employees can directly influence their salaries by demonstrating high performance results, which leads to a greater than average salary increase throughout the company.

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Another fact supporting companies’ intention to use an individual approach to their employees is the growing popularity of complex personnel performance appraisal systems. The number of companies using KPI (Key Performance Indicators) or MBO (Management by Objectives) systems for the appraisal of each employee’s efficiency is growing from year to year. In addition, more and more companies apply special principals of work that differ from the general ones for certain personnel categories. In general these categories include young professionals or experts/ specialists with unique knowledge in certain areas which are vitally important for the companies. The popularity of talent management systems is also growing. They enable companies to identify high-potential employees on a regular basis, to invest in the development of such employees and to use their potential in favor of the company. At present, more than half of companies in Russia apply these systems. The opposite side of the process of identifying “the very best” employees and developing them is the retention of such employees in the company. Rotation programs, detailed career plans and individual compensation packages are the tools used for employees’ retention.


However, even with a wide range of retention tools, companies are not able to retain all key employees. In order to avoid the negative consequences of such losses companies can introduce instruments, depending on personnel categories, like a continuing process of certain personnel category sourcing, promoting talents and experts inside the company and a system of knowledge accumulation. Companies’ headcount plans also indicate a stable situation on the labor market – 62% of companies participating in the Compensation and benefits survey plan to maintain their current headcount levels. At the same time the number of companies planning headcount reductions decreased by four percentage points in comparison with last year and reached 9%. About onethird of companies plan to increase their headcount. The number of companies planning a headcount increase varies from region to region. As usual, it is highest in regions that have a lot of government funded projects or that attract considerable foreign capital, and lowest in regions with poor investment activity. Personnel turnover and its key indicator, the attrition rate, have been stable for the last two years. In 2010 and 2011, an average attrition rate was 12%-13%, based on the survey results. Moreover, companies

anticipate a slight decrease in that figure next year – by 1-2 percentage points. The challenge of cost reduction faced by many organizations, and in particular by their HR departments, bore fruit in 2008. At present, more and more companies pay particular attention to their efficiency on a regular basis. Thus, cost optimization and growth of operational efficiency are becoming key focal points for all functional departments, including HR. According to the EY Labor market survey, more than half of companies (58%) regularly conduct HR performance monitoring. Typically, the companies monitor key performance indicators and their dynamics, which reflect the quality of HR, as well as conduct surveys indicating the rest of the company’s departments’ satisfaction with HR.

As a method of enhancing operational efficiency, the popularity of such a method as outsourcing or delegating routine technical HR functions which do not require deep expertise (payroll, HR document flow, etc.), to external providers is growing. Based on the 2012/2013 survey results, 30% of companies outsource such functions, while last year there were only 24% of participants applying to providers. Shared Service Center (SSC) is a more complex approach in terms of optimizing HR functions and enhancing HR efficiency. The foundation of one Shared Service Center enables a group of companies to transfer uniform HR processes to the single center, to standardize and atomize them and, therefore, to reduce time consumed on tasks’ performance, as well as to reduce operational costs. Shared Service Centers are wide-spread all over the world. However,


in Russia they are just starting to gain popularity. The main obstacle in this area is an implementation of unified IT-systems, which requires prior systematization and unification of business processes, document flow and corporate communications. In conclusion, it is necessary to notice that performance efficiency tasks will be the number one priority for a long time into the future. While the potential of the traditional approaches to performance management is almost depleted, employers introduce new complex tools. Those who ensure a continuous character of the process of performance improvement, identifying week areas and optimizing them, gain success. Personnel is one of the key resources of any organization, thus HR has become a vast area of struggle for efficiency, where real actions are going to be taken.

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Contacts Almaty +7 (727) 258 5960

Moscow +7 (495) 755 9700

Astana +7 (7172) 58 0400

Novosibirsk +7 (383) 211 9007

Atyrau +7 (7122) 99 6099

St. Petersburg +7 (812) 703 7800

Baku +994 (12) 490 7020

Tashkent +998 (71) 140 6482

Donetsk +380 (62) 340 4770

Tbilisi +995 (32) 243 9375

Ekaterinburg +7 (343) 378 4900

Togliatti +7 (8482) 99 9777

Кazan +7 (843) 567 3333

Vladivostok +7 (423) 265 8383

Kyiv +380 (44) 490 3000

Yerevan +374 (10) 500 790

Krasnodar +7 (861) 210 1212

Yuzhno-Sakhalinsk +7 (4242) 49 9090

Minsk +375 (17) 209 4535

Contact Peter Reinhardt Tel: +7 (495) 705 9738 [email protected]

Zhanna Dobritskaya Tel: +7 (495) 755 9675 [email protected]

Anton Ionov Tel: +7 (495) 755 9747 [email protected]

Ekaterina Ukhova Tel: +7 (495) 641 2932 [email protected]

© 2012 Ernst & Young (CIS) B.V. All Rights Reserved.

October 2012 Quarterly review People Focus - Ernst & Young

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