Executive remuneration policy

Policy: introduction
The overriding objective of the British American Tobacco remuneration policy is to reward the achievement of corporate and individual goals by linking success in those areas to the Group strategy: a balanced approach to achieving growth, improving productivity, managing the business in a responsible manner and developing a winning organisation. The delivery of strategy is measured by the Key Performance Indicators (KPIs) and Business Measures set out and described in the Our strategy section of the Annual Review. The continued focus by the Executive Directors of British American Tobacco and the members of its Management Board on driving all four elements of the strategy, will continue to build a sustainable business. This methodology is supported by a competitively positioned and integrated pay and benefits structure which reflects the nature of the Group’s worldwide operations and the need to attract, motivate and retain high-quality executives.

In order to strengthen the alignment of executive remuneration to the generation of shareholder value, a balance is maintained between the short and long term elements of the structure. This policy will continue to be applied during 2007.

Policy: remuneration balance
The role of the Remuneration Committee is to determine the framework and policy on terms of engagement (including remuneration) of the Chairman (Jan du Plessis), the Executive Directors (Paul Adams, Antonio Monteiro de Castro and Paul Rayner) and the members of the Management Board. It also determines the specific remuneration of each of them (including awards under share incentive schemes and pension schemes) and any compensation payments. In developing and applying the framework and policy, the Committee has a guideline that approximately 50 per cent of the remuneration (assuming ‘on target’ performance) should be of a performance-related or variable nature. The remuneration package comprises both performance-based variable rewards (cash and share incentive annual bonus plans; Long Term Incentive Plan) and core fixed elements (base salary; pension and other benefits). The composition in the case of Executive Directors for 2006 and 2007 is as follows:

	Fixed element per cent		Variable element per cent (on target performance)
	2006	2007	2006	2007
P N Adams	44	40	56	60
P A Rayner	47	43	53	57
A Monteiro de Castro	52	48	48	52

Notes:
1 The variable elements shown for 2007 take into account awards to be made under the proposed new Long Term Incentive Plan which is summarised below.

2 For members of the Management Board, this policy typically translates for 2007 into a fixed element at 52 per cent (2006: 53 per cent) and a variable element at 48 per cent (2006: 47 per cent).

Review of incentive arrangements and proposed new Long Term Incentive Plan

Background: strategy
The Company’s current Long Term Incentive Plan (the Current LTIP) will expire in April 2008 and in anticipation of that event, the Remuneration Committee appointed Deloitte & Touche LLP to undertake a comprehensive review of the current incentive arrangements for the senior executive team and to advise on possible replacement incentive arrangements to support the executive remuneration policy and its embedded link with the Group strategy. This review also assimilated data from Towers Perrin, the remuneration consultants to the Committee (the Review).

The following key principles were confirmed by the Committee during the Review: (1) there should continue to be a single global incentive plan for all participants, thereby supporting British American Tobacco’s global strategy and culture; (2) a performance-based share plan structure continues to be right for the business, and should continue to be the only long term performance-based plan operated by the Company; (3) Total Shareholder Return (TSR) and earnings per share (EPS) continue to be the most appropriate measures of British American Tobacco’s performance on the basis that these measures are aligned with shareholders’ interests and with British American Tobacco’s key goal of achieving (on average) high single digit earnings growth.

As a result of the Review, shareholder approval is being sought for a new Long Term Incentive Plan (the New LTIP). Details of the New LTIP will be set out in the notice for the 2007 Annual General Meeting and its accompanying letter from the Chairman of the Remuneration Committee, the key points of which are summarised below.

Background: Current LTIP
The Current LTIP provides for awards of free ordinary shares to the Executive Directors and senior employees, provided certain demanding performance conditions are met. The Current LTIP is operated each year by the Remuneration Committee in relation to awards to the Executive Directors and members of the Management Board. Awards under the Current LTIP have been made at a level of 175 per cent of salary for the Chief Executive and 125 per cent of salary for the other Executive Directors and members of the Management Board.

For awards made since 2005, participants have been entitled to receive a cash payment equivalent to the value of the dividends that they would have received as shareholders on their vesting awards (the LTIP Dividend Equivalent). The value of the LTIP Dividend Equivalent has been taken into account when considering awards under the Plan.

Awards are based on a combination of TSR and EPS performance conditions measured over three years. The Remuneration Committee considers that both of these measures are widely accepted and understood benchmarks of a company’s performance, and that together they provide a good spread of measures relevant to the Group’s business and market conditions. These are outlined in the following long term incentive proposals.

Summary of proposed Plan
Shareholder approval is being sought for the introduction of the New LTIP to replace the Current LTIP which expires in 2008. The proposed new Plan, in which all Executive Directors and members of the Management Board would participate, is, in many respects, very similar to the existing arrangements, although there are some differences which are identified and described below. Awards under the New LTIP would continue to deliver shares subject to stretching performance conditions over three years. Participants would also continue to receive the LTIP Dividend Equivalent.

The performance conditions for the awards would continue to be based on TSR and EPS measures as follows:

TSR performance condition
In line with the approach taken under the Current LTIP, a total of 50 per cent of the total award will be based on the Company’s TSR performance against two comparator groups (25 per cent for each measure): (1) the constituents of the London Stock Exchange’s FTSE 100 Index at the beginning of the performance period; and (2) a peer group of international fast-moving consumer goods (FMCG) companies. 25 per cent of the total award vests in full in the event of upper quartile performance by the Company relative to one of the comparator groups above, 7.5 per cent of the total award will vest in the event of median performance, and with pro rata vesting between these two points. The TSR portions of an LTIP award would not vest for below median performance.

These comparator groups, which will be kept under review to ensure that they will remain both relevant and representative, are chosen to reflect, as far as possible, the Company’s financial and business trading environments.

TSR will continue to be measured according to the return index calculated by Datastream and reviewed by the Company’s independent advisers. It is measured on the basis that all companies’ dividends are reinvested in the shares of those companies. The return is the percentage increase in each company’s index over the three year performance period. The opening and closing indices for this calculation are respectively the average of the index numbers for the last quarter preceding the performance period and for the last quarter of the final year of that performance period – this methodology is employed to reflect movements of the indices over that time as accurately as possible.

The constituent companies for the proposed FMCG group for the first awards under the New LTIP are identified in Table 7.

TSR will continue to be measured on a local currency basis. This approach is considered to have the benefits of simplicity and directness of comparison with the performance of the comparator companies, and is in line with the approach currently taken for the purposes of TSR measurement.

EPS performance condition
50 per cent of an award under the Current LTIP and the New LTIP will be based on EPS growth relative to inflation. This element of the award will vest fully if EPS growth over the three year performance period is an average of at least 8 per cent per annum in excess of inflation; 10 per cent of this element will vest if the same figure is at least 3 per cent in excess of inflation, and an award will vest on a pro rata basis between these two points. The EPS portion of an award would not vest below these points.

Growth in EPS for these purposes is calculated on an adjusted diluted EPS basis using a formula which incorporates: (1) the adjusted diluted EPS for the year prior to the start of the first performance period and then for the first, second and third years of that performance period; and (2) retail price index (RPI) for the last month of the year immediately preceding the performance period, and then the RPI for the respective first, second and third years of that performance period.

The proposed targets are in line with and support British American Tobacco’s strategy to deliver high single digit (nominal) EPS growth. The maximum target would require 8 per cent per annum growth in earnings ahead of inflation and is considered to be very demanding. The Remuneration Committee will keep these targets under review to ensure that they continue to be appropriately stretching.

Award levels
The Remuneration Committee continues to maintain a responsible approach to benchmarking and aims to set the total compensation opportunity for Executive Directors within the market competitive range, but with a conservative overall positioning. As part of the Review, the Committee decided to maintain a simple, focused incentive structure with only two elements of variable pay. This methodology is in contrast to a number of FTSE 100 companies which may operate two or, in a few cases, three different long term incentive plans in the same year. The Remuneration Committee believes that the Company’s approach will provide a clear message to participants of what is required and will be transparent to shareholders.

The Remuneration Committee has an established peer group for benchmarking purposes, made up of FTSE 100 companies with a consumer goods focus, an international spread of operations and competitors for top management talent. This group of UK listed companies (the Salary Comparator Group) has been used for a number of years to ensure that base salaries and total compensation continue to be market competitive and is subject to annual review. The companies in the Salary Comparator Group as at 31 December 2006 are set out in Table 6.

The opportunity provided by the total package was compared against the Salary Comparator Group on both an expected and projected value basis, taking into account the value of the LTIP Dividend Equivalent. Under both these approaches, the total compensation opportunity for the Executive Directors, and in particular the Chief Executive, was positioned appreciably below the mid-market.

To ensure that remuneration levels remain competitive (subject to the approval of shareholders), awards under the New LTIP will therefore be increased from 175 per cent to 250 per cent of base salary for the Chief Executive, and from 125 per cent to 200 per cent of base salary for the Finance Director and the Chief Operating Officer. In this way, the total package continues to be positioned appropriately against the market.

The level of award for members of the Management Board will also be increased from 125 per cent of salary to 150 per cent of salary.

In order to provide flexibility and sufficient capacity for future awards over the life of the Plan, the individual limit will be increased to 300 per cent of salary. The Remuneration Committee does not anticipate that awards will be made up to this limit in normal circumstances, and there is no current intention to utilise this limit by making awards in excess of the proposed levels. The Remuneration Committee will advise shareholders in advance of any change in the current proposed award levels, and any such change will be disclosed in the Remuneration Report.

Salary

Salaries for the Executive Directors and members of the Management Board are reviewed annually or on a significant change of responsibilities. In deciding appropriate salary levels, and to ensure competitive positioning, Executive Directors’ salaries are benchmarked against a mid-market level of main board directors from the Salary Comparator Group described above. Where necessary, additional reference is also made to published salary data, including that for positions for companies in the Salary Comparator Group.

Matched salary positions are identified and compared using factors chosen to cover comparative reporting levels, revenue, international responsibilities and main board membership. This enables a mid-market assessment and a ‘competitive range’ (typically 15 to 20 per cent either side of the assessment) to be reported to the Committee, which will then make judgements within this range depending on individual performance and experience.

Salaries of members of the Management Board are reviewed on the basis of a mid-market comparison for equivalent management board roles. Similar principles are applied to the salaries of senior managers and, below this level in the organisation, salary scales are graded with reference to market conditions whilst individual salary increases are linked to performance.

During 2006, the Committee continued to recognise that the requirements of recruitment or retention may on occasion justify the payment of a salary outside the range regarded as appropriate for a particular position.

In addition to basic salary, the Executive Directors and members of the Management Board receive certain benefits in kind, principally a car or car allowance and private medical and personal accident insurance. The Executive Directors also receive the benefit of the use of a driver.

Executive Directors’ performance-related bonus plans

With effect from 1 January 2006, the Executive Incentive Scheme (annual cash bonus) and the Deferred Share Bonus Scheme were combined under one vehicle to create a higher impact, more focused and simpler annual incentive arrangement called the International Executive Incentive Scheme (IEIS). The Executive Directors participate in the IEIS, which is an annual bonus scheme for senior managers, comprising both a cash and deferred shares element. The deferred shares element is delivered through the Deferred Share Bonus Scheme (the Deferred Scheme). The IEIS aims to reward short term performance within the context of longer term sustainability.

The role of the IEIS was also considered during the long term incentive review referred to above; there are no changes currently planned or proposed to the annual bonus arrangements.

Bonus entitlements and awards to the Executive Directors and members of the Management Board under the IEIS depend upon the performance of the business. Demanding targets are set by the Remuneration Committee at the beginning of each year, and are measured in terms of both financial and business performance. Since the beginning of 2006, the targets for the IEIS reflect five common measures: underlying operating profit, market share of key player volume, Global Drive Brand volume, net revenue and cash flow. These measures, identified as being key to sustained performance, have an equal weighting of 20 per cent each. Payouts for each target are determined on a sliding scale with three performance points: threshold (which must be exceeded to attract a bonus); target; and maximum amount (the level at which the bonus is capped). The specific targets are not disclosed as they are considered to be commercially sensitive.

The performance points are calculated at the start of the year by reference to the type of target and projected performance in the context of the Group’s annual budget. The Committee receives reports from internal functions to allow it to determine the extent to which performance measures have been achieved. No elements of the bonuses are guaranteed. Bonuses will be equally delivered in cash and shares.

Awards made under the Deferred Scheme are in the form of free ordinary shares in the Company which are normally held in trust for three years and no further performance conditions apply in that period. In certain circumstances, participants may forfeit the shares if they resign before the end of the three year period. The Remuneration Committee is keen to encourage a culture of ‘ownership’ of these awarded shares and, since April 2004, participants have received a cash sum equivalent to the dividend on the after tax position of all unvested ordinary shares held in the Deferred Scheme at the dividend record date.

For the Executive Directors, the cash and shares elements of the IEIS taken together carry a value of 100 per cent of base salary for ‘on target’ performance, with an overall maximum of 150 per cent. For the members of the Management Board, both elements taken together carry a value of 67 per cent of base salary for ‘on target’ performance, with an overall maximum of 100 per cent. The Committee, following its usual procedures, agreed that the performance targets for the year ended 31 December 2006 have been met (subject to confirmation of a figure yet to be published). These performance-related bonus payments are included in Table 1, in the year to which they relate.

Directors’ interests in shares

The interests of the Directors of the Company in the issued share capital of the Company, according to the register maintained under Section 325 of the Companies Act 1985 (which is open to inspection at the registered office), together with their interests in share options, are shown in Table 2.

The Remuneration Committee continues to promote its shareholding guidelines under which Executive Directors and members of the Management Board are encouraged to work towards holding ordinary shares in the Company to the values of one times and 0.75 times base salary respectively.

Share options and share incentive schemes

The Executive Directors are eligible to participate in the following employee share schemes which are designed to incentivise employees of the Group by giving them opportunities to build a shareholding in the Company: the British American Tobacco Sharesave Scheme (Sharesave Scheme), the Employee Share Ownership Plan and the Current LTIP. Executive Directors have also participated in the British American Tobacco Share Option Scheme (Share Option Scheme) and in line with current policy, no options have been granted to Executive Directors or other participants under the Share Option Scheme since March 2004. The Share Option Scheme will expire in April 2008 and there is no intention to renew it.

All benefits under the employee share schemes are non-transferable and non-pensionable.

Sharesave Scheme
Eligible employees, including the Executive Directors, have been granted employee savings-related share options to subscribe for ordinary shares in the Company. In November 2006, the Company made a further grant of options under the Sharesave Scheme which allows for options granted to be exercisable in conjunction with either a three year or five year savings contract up to a monthly limit of £250. Options are normally granted at a discount of 20 per cent to the market price at the time of the invitation, as permitted under the rules of the Sharesave Scheme. At 31 December 2006, all the Executive Directors participated in the Sharesave Scheme, each saving the maximum monthly amount.

The Sharesave Scheme in its current form, which was initially approved by shareholders in 1998, will expire in April 2008. The Remuneration Committee has recommended that the Company continue to operate a Sharesave Scheme and that shareholders’ approval to renew the Sharesave Scheme for a further 10 years will be sought at the 2007 Annual General Meeting.

The rules of the renewed Sharesave Scheme will be substantially unchanged, although there is some updating of statutory references and the inclusion of provisions allowing for electronic communications. In order to bring the limits on the number of new shares which may be issued pursuant to the exercise of options granted under the Sharesave Scheme in line with current ABI guidelines and market practice, the Sharesave Scheme will be amended to provide for a single limit on the number of shares which may be issued under the scheme in any 10-year period of 10 per cent of the Company’s issued share capital. The Sharesave Scheme will continue to be approved by HM Revenue & Customs (HMRC), who have given their preliminary approval to the extension of the scheme in its amended form.

Employee Share Ownership Plan
The Employee Share Ownership Plan is an HMRC approved share incentive plan. The Company continues to operate its Partnership Share Scheme as a key constituent part of this Plan. The Partnership Share Scheme is open to all eligible employees, including Executive Directors. Employees can allocate part of their pre-tax salary to purchase shares in British American Tobacco. The maximum amount that can be allocated in this way is £1,500 in any year. Shares purchased are held in a UK-based trust, normally capable of transfer to participants tax free after a five year holding period. At 31 December 2006, all the Executive Directors participated in the Partnership Share Scheme, each investing the maximum monthly contribution.

The Company also operates the Free Shares element of the Plan, known as the Share Reward Scheme. Under this Scheme, eligible employees (including Executive Directors) receive an appropriation of shares in April of each year in which the Scheme operates in respect of performance in the previous financial year. In this way, an award will be made on 2 April 2007 in respect of the year ended 31 December 2006, subject to the performance conditions being met. For the Executive Directors, the performance conditions were aligned to those set for the IEIS in respect of the same performance period. The shares are held in a UK-based trust for a minimum period of three years. The maximum individual award under the Share Reward Scheme is £3,000.

Share Option Scheme
It is the policy of the Remuneration Committee not normally to grant options in any year to individuals who receive an award under the LTIP. No options have been granted under the Share Option Scheme since March 2004, with no options having been granted to the current Executive Directors since September 1999. As mentioned above, the Share Option Scheme expires in April 2008 and there is no intention to renew it. One Executive Director, Paul Rayner, holds outstanding options under the Share Option Scheme; these options were granted to Mr Rayner prior to his appointment as a Director in 2002.

Options already granted under the Share Option Scheme were not issued at a discount to the market price at the time of grant, with the value of options for that grant being limited to 50 per cent of a participant’s base salary. Options are normally exercisable after the third anniversary of the date of the grant and lapse 10 years after the date of their original grant, subject to a performance condition based on EPS growth. For options to be exercisable, the Company’s published adjusted diluted EPS growth has to exceed inflation by an average of 3 per cent per annum over any consecutive three year period during the 10 year life of the options.

Current LTIP
Details of the framework and general operating parameters of the Current LTIP have been included as part of the summary of the Review and the proposed New LTIP referred to above, in which it is noted that the Current LTIP will expire in April 2008 and, subject to the required shareholders’ approval, the first awards under the New LTIP will be made in May 2007. Therefore, no further awards will be made to the Executive Directors and the members of the Management Board under the Current LTIP.

Performance
To the extent that the performance conditions have been satisfied following assessment by the Remuneration Committee, awards are normally exercisable between three and 10 years after they have been made. An award of shares lapses to the extent that the performance conditions are not satisfied in accordance with the measures set out above at the end of the three year performance period. The Remuneration Committee considers that a three year performance period for the Current LTIP gives a balance between the aspirations of the Executive Directors, the members of the Management Board and shareholders.

As stated last year, the transition to International Financial Reporting Standards (IFRS) for financial years beginning on or after 1 January 2005 has impacted profits-based measures such as EPS. The Committee has noted that IFRS is still changing and that the concepts of what should be income, and consequently the basis for EPS measures, may well undergo fundamental change as future standards are developed. The Committee, however, continues to be committed to ensuring a consistent approach to measurement of performance for the vesting of LTIP awards.

Vesting of 2004 LTIP award
As reported last year, 77.1 per cent of the 2003 LTIP award vested on 19 March 2006. The sixth LTIP award was made in 2004, with the performance period being completed at 31 December 2006. The Remuneration Committee has assessed the performance of British American Tobacco against the two performance conditions outlined above and has determined that: (1) the effects of the transition to IFRS stated above have not had a material impact on the measurement of EPS growth used for the LTIP; and (2) 100 per cent of the award will vest. On the TSR measure, the Company ranked 10th out of the FTSE 100 group of companies, giving a vesting of 25 per cent for performance at the upper quartile. A vesting of 25 per cent was achieved for ranking second out of the peer group of international FMCG companies, this being upper quartile. EPS growth was 8.98 per cent per annum in excess of inflation, resulting in a vesting of 50 per cent. Members of the FMCG group for the 2004 award vesting in March 2007 are set out on in Table 7.

Performance graph
Schedule 7A to the Companies Act 1985 requires that the Company must provide a graph comparing the TSR performance of a hypothetical holding of shares in the Company, with a broad equity market index over a five year period. In this context, the Directors have again chosen to illustrate the performance of TSR against the FTSE 100 Index over a five year period, commencing on 1 January 2002. In the opinion of the Directors, the FTSE 100 Index is the most appropriate index against which TSR should be measured, because it is a widely used and understood index of broadly similar-sized UK companies to the Company. The performance graph is shown below.

In addition to the performance graph, illustrative graphs that show the relative position on the TSR measures for the LTIP award vesting in March 2007 are shown below.

 Options and awards outstanding: employee share ownership trust

To satisfy the future exercise of options or awards under the Group’s employee share schemes, ordinary shares are acquired in the market by an existing employee share ownership trust – the British American Tobacco Group Employee Trust (BATGET). During the year, new ordinary shares were issued by the Company in relation to the Sharesave Scheme and to certain participants in the Share Option Scheme resident outside the UK.

Under the Sharesave Scheme, a total of 2,507,461 options over ordinary shares in the Company were outstanding at 31 December 2006. The options outstanding under the Sharesave Scheme are exercisable until June 2012 at option prices ranging from 480p to 1,152p.

BATGET is used to satisfy the future exercise of options under the Share Option Scheme and the vesting and exercise of awards of ordinary shares made under the Deferred Scheme and the LTIP respectively. BATGET is funded by interest-free loan facilities from the Company totalling £300 million, enabling the Trust to facilitate the purchase of ordinary shares to satisfy the future vesting or exercise of options and awards. The loan to BATGET amounted to £248 million at 31 December 2006(2005: £198 million). The loan will be repaid from the proceeds of the exercise of options or, if the options lapse, ordinary shares may be sold by BATGET to cover the loan repayment or, in the case of ordinary shares acquired by BATGET to satisfy the vesting and exercise of awards, the Company will subsequently waive the loan provided over the life of the awards.

BATGET currently waives dividends on the ordinary shares held by it as an employee share ownership trust. As at 31 December 2006, BATGET held 19,252,345 ordinary shares with a market value of £275.1 million (1 January 2006: 22,751,064 ordinary shares; £295.8 million). BATGET waived payment of the final dividend for 2005 of £7.2 million in May 2006 and the interim dividend for 2006 of £3.2 million in September 2006.

Executive Directors’ pensions benefits

The Executive Directors (with the exception of Antonio Monteiro de Castro) are, like other employees, eligible for membership of the British American Tobacco UK Pension Fund (Pension Fund).

The Pension Fund is a non-contributory defined benefit scheme and includes provision for spouses’ benefits on death in service or after retirement. In the event of death in service, a spouse’s pension equal to half of the member’s prospective pension at normal retirement age, would be payable. A spouse’s pension payable in the event of death after retirement is equal to half of the member’s full pension, irrespective of any decision to exchange part of the benefit for a lump sum. The early retirement rules in the Pension Fund permit a member to draw the accrued retirement pension within five years of normal retirement age without actuarial reduction, subject to the employing company’s agreement. Alternatively, an Executive Director may choose to retire at any time on or after his or her 50th birthday without the employing company’s agreement, subject to a reduction as determined by the Pension Fund trustee in conjunction with the Pension Fund actuary. Accrual rates differ according to individual circumstances but do not exceed one-fortieth of pensionable salary for each year of pensionable service. Pensionable pay covers basic salary only.

Paul Adams and Paul Rayner both joined the Pension Fund after 1989. As a result, prior to 6 April 2006, both individuals were subject to the HMRC cap on pensionable earnings (£108,600 for the tax year 2006/07). In addition, each has an unfunded pension promise from the Company in respect of earnings above the cap on an equivalent basis to the benefits provided by the Pension Fund. This is provided through membership of an unfunded unapproved retirement benefit scheme.

However, following the changes in pensions legislation in 2006, it was agreed that benefits up to £75,000 per annum (targeting the Lifetime Allowance) would be provided through the Pension Fund, with the remainder of benefits being provided through the unfunded arrangement. As a result, the Company paid an additional amount to the Pension Fund in 2006 to fund the additional benefits up to a maximum of £75,000 per annum. The overall pension entitlement for each of the Executive Directors remained unchanged. Paul Adams and Paul Rayner, being members of the Pension Fund, are entitled to receive increases in their pensions in line with price inflation up to 6 per cent per annum.

These unfunded commitments are included in the provisions referred to in note 12 to the accounts.

Paul Rayner has an accumulated defined contribution entitlement from Division A of the British American Tobacco Australia Superannuation Fund. No contributions were paid to this arrangement on behalf of Paul Rayner during 2006.

Antonio Monteiro de Castro is in receipt of a pension based on an accrual rate of 1.85 per cent for each year of service from the Fundaçao Albino Souza Cruz, having retired from this scheme in accordance with its rules in May 2005 upon attaining his 60th birthday. This pension will be increased annually by the lesser of the same index Souza Cruz S.A. (Souza Cruz) applies to general salary increases and the General Price Index. In respect of service with Souza Cruz, Antonio Monteiro de Castro is also entitled to a pension equivalent to 0.65 per cent of pensionable salary for each year of service to his 60th birthday as an unfunded pension promise, increasing his total pension entitlement to 2.5 per cent, the value of which will be paid to him upon his retirement from the Group. With effect from June 2005, Antonio Monteiro de Castro participates in an unfunded unapproved retirement benefit scheme accruing benefits at the rate of 2.5 per cent per annum. At retirement, Antonio Monteiro de Castro will be entitled to a total pension based on his service with the Group, calculated using the 12 month average of his basic salary prior to retirement. This benefit will be reduced by the benefits paid and payable by Souza Cruz as assessed by independent actuaries.

Executive Directors’ service contracts

The Remuneration Committee continues to operate a policy of one year rolling contracts for Executive Directors. Each Executive Director has such a contract, executed at the time of his original appointment. The contract may be re-executed during the term of his employment to take account of variations in terms and conditions, as well as changes in best practice; the contractual term will continue to be of a one year rolling period. In addition, the Remuneration Committee maintains discretion in respect of this policy for those future Executive Directors who may be recruited externally or from overseas, when it may be appropriate to offer a contract with an initial period of longer than one year, reducing to a one year rolling contract after the expiry of the initial period. It is the policy that an Executive Director’s one year rolling contract incorporates a provision for a termination or compensation payment in lieu of notice.

An Executive Director’s compensation payment, in lieu of notice, would comprise: (1) 12 months’ salary at his then current base pay; and (2) a cash payment in respect of other benefits under the contract such as medical insurance, or the Company may at its option continue those benefits for a 12 month period. The Committee maintains discretion as to how to deal with any grants or awards made prior to termination under the Share Option Scheme, the Deferred Scheme and the LTIP. Pension entitlements are dealt with in accordance with the terms and conditions of the applicable pension scheme and do not form part of the contractual compensation payment.

The compensation payment is payable where the requisite 12 months’ notice is not given to the Executive Director or when he terminates by giving 12 months’ notice and the Company does not wish him to serve his notice. If a period of notice is served, the compensation payment is reduced pro rata. In the unlikely event that the contract is terminated for cause (such as gross misconduct), the Company may terminate the contract with immediate effect and therefore no compensation payment would be payable.

External appointments

Executive Directors and members of the Management Board are able to accept one substantive external board appointment, provided that permission is respectively sought from the Board or Chairman. With effect from1 January 2006, the fees from such appointments have been retained for a Director’s own account, thereby recognising the increasing level of personal commitment and expertise required for non-executive roles. Paul Rayner is currently a Non-Executive Director of Centrica p.l.c. and the fees from this appointment for the year ended 31 December 2006 totalled £65,000.

Non-Executive Directors’ terms of appointment

The Non-Executive Directors do not have service contracts with the Company but instead have letters of appointment. The terms of appointment of each Non-Executive Director provide that a new Director is appointed for a specified term, being an initial period to the next Annual General Meeting after appointment and, subject to reappointment at that meeting, for a further period ending at the Annual General Meeting held three years thereafter. Subsequent reappointment is subject to endorsement by the Board and the approval of shareholders. The date of appointment and most recent reappointment is shown below for each Non-Executive Director:

	Date of appointment	Date of last reappointment at Annual General Meeting
K H Clarke	28 April 1998	28 April 2005
P E Beyers	22 June 2004	28 April 2005
R E Lerwill	01 January 2005	28 April 2005
A M Llopis	24 February 2003	27 April 2006
R L Pennant-Rea1	28 April 1998	27 April 2006
A Ruys	01 March 2006	27 April 2006
Sir Nicholas Scheele	28 February 2005	28 April 2005
M H Visser	01 April 2001	28 April 2005

Note:
1 Rupert Pennant-Rea was a Non-Executive Director of B.A.T Industries p.l.c. from 1 November 1995 until 7 September 1998. He is scheduled to retire at the conclusion of the 2007 Annual General Meeting.

On termination, at any time, a Non-Executive Director is entitled to any accrued but unpaid Director’s fees but not to any other compensation.

Non-Executive Directors’ remuneration policy

The fees for the Non-Executive Directors are determined by the Board, on the recommendation of the Chairman and the Chief Executive, within the overall aggregate limit of £2,000,000 authorised by shareholders with reference to the Company’s Articles of Association. The Non-Executive Directors do not participate in discussions with the Board about their own remuneration.

The fees paid to the Non-Executive Directors are determined in light of market best practice and with reference to the time commitment and responsibilities associated with the roles. In order to recognise the increased focus on the roles and responsibilities of the Non-Executive Directors, and the need to ensure that the Company is able to continue to attract and retain high calibre individuals to such non-executive roles, the fees for the Non-Executive Directors have been revised by the Board with effect from 1 January 2007 as follows: Deputy Chairman £165,000; Non-Executive Directors £75,000, with an additional £20,000 being payable to the Chairman of the Audit Committee.

Non-Executive Directors receive no other material pay or benefits (with the exception of reimbursement of expenses incurred in respect of their duties as Directors of the Company). It is the policy of the Board that the spouses of the Executive Directors and Non-Executive Directors may accompany the Directors for business purposes on designated trips and functions during the year.

Chairman’s terms of appointment and remuneration

The Remuneration Committee is responsible for determining the terms of engagement and fees payable to the Chairman. This process takes into account the breadth of that role coupled with its associated levels of commitment and expertise. Jan du Plessis’s terms of appointment provide that he holds the office of Chairman of the Company with effect from 1 July 2004 for a period of three years unless terminated earlier by: (1) the Company giving three months’ notice or a discretionary compensation payment in lieu of notice; or (2) by the Chairman giving one month’s written notice with the Company having discretion to make a compensation payment in lieu of such notice. The compensation payment is limited to any fees which are payable for such part of the relevant notice period as the Board does not require the Chairman to perform his duties.

As a Director of the Company, the Chairman is subject to the reappointment of Directors provisions contained in the Company’s Articles of Association. The date of his last reappointment as a Director was at the Annual General Meeting held on 27 April 2006. The terms of Jan du Plessis’s appointment provide for: (1) an annual fee of £535,000; (2) the use of a driver; and (3) private medical and personal accident insurance. In common with the Non-Executive Directors, the Chairman does not participate in the British American Tobacco share schemes, bonus schemes or incentive plans and is not a member of any Group pension plan.

Copies of the Executive Directors’ service contracts and the details of the terms of appointment of each Non-Executive Director and the Chairman are available for inspection during normal business hours at the Company’s registered office and will also be available for inspection at the Annual General Meeting on 26 April 2007.

Appendices to the Remuneration Report

The Remuneration Committee
Terms of reference
The terms of reference of the Remuneration Committee, together with an explanation of its role and the authorities delegated to it by the Board, are available from the Company Secretary on request and can be accessed on the corporate governance section of the Company’s website at bat.com

Membership
At the date of this report, the Committee comprises the following independent Non-Executive Directors of the Company: Kenneth Clarke (Chairman of the Remuneration Committee); Robert Lerwill; Ana Maria Llopis; Rupert Pennant-Rea; Anthony Ruys (appointed 1 March 2006) and Sir Nicholas Scheele. The Secretary to the Committee is Nicola Snook, the Company Secretary.

No Executive Director or other member of the Management Board plays any part in determining his or her remuneration. During the year ended 31 December 2006, the Chief Executive was consulted and invited to attend meetings of the Committee, except when his own remuneration was under consideration. In determining remuneration for the year, the Committee consulted the Chief Executive, the Director, Human Resources and the Head of Reward. The Chairman, Jan du Plessis, was also consulted and invited to attend meetings of the Committee. The Committee appointed Towers Perrin as remuneration consultants, to provide remuneration services and advice to the Company for 2006, with specific reference to the needs of the Remuneration Committee. Towers Perrin isa leading international firm of remuneration and benefits consultants. It also provides general consultancy services and advice to British American Tobacco Group companies around the world on pay, pensions and other human resources related issues. As referred to above, Deloitte & Touche LLP were appointed to undertake a comprehensive review of the current incentive arrangements for the senior executive team. Herbert Smith LLP have also been retained by the Company to provide legal advice in respect of the Company’s share schemes, as well as providing other legal services to British American Tobacco as a whole.

Status of Remuneration Report

This Report has been prepared in accordance with Schedule 7A to the Companies Act 1985. The Report also meets the relevant requirements of the Listing Rules of the UK Listing Authority and describes how the Board has applied the Principles of Good Governance relating to Directors’ remuneration as set out in the Combined Code on Corporate Governance referred to in the Corporate Governance Statement. As required by the Companies Act 1985, a resolution to approve the Directors’ Remuneration Report (Report) will be proposed at the Annual General Meeting of the Company on 26 April 2007, at which the Financial Statements will be presented for approval. The vote will have advisory status, will be in respect of the remuneration policy and overall remuneration packages and will not be specific to individual levels of remuneration.

The Companies Act 1985 requires the auditors to report to the Company’s shareholders on the ‘audited information’ within the Report and to state whether, in their opinion, those parts of the Report have been prepared in accordance with the Companies Act 1985. The Auditors’ Report is set out in Report of the independent auditors and those aspects of the Report which have been subject to audit have been clearly marked: Table 1, Table 3, Table 4 and Table 5.

On behalf of the Board

Kenneth Clarke
Chairman of the Remuneration Committee

1 March 2007