Employee Incentive Schemes

Employee Incentive Schemes

As employee retention once again becomes an issue for employers, employee share incentive schemes offer a tax efficient means of giving employees ‘skin in the game’ and thereby encouraging motivation and loyalty.

The multiplicity of ways that such arrangements can be structured means that whatever size your business or whatever your circumstance, there is a scheme that can be tailored to suit your company.

We have set out below a summary of some of the typical structures used:-

  1. Share options
    The employee is granted an option to acquire shares at some point in the future at a fixed price.  The option may set a time period within which it can be exercised or set out trigger events which would give rise to an exercise entitlement such as a sale of the company.    Employees are only likely to exercise the options in circumstances where the exercise price is less than the market value and there is the risk that the options may become worthless or have little value.    The option will often lapse if unexercised when the employee leaves but the employee is usually free to sell the shares as they wish once the option is exercised.  The taxable event for the employee arises on exercise of the option whereby they are taxed on the difference between the price paid and the market value at the time of exercise.
  2. Revenue Approved Schemes
    As the name suggests, such scheme agreements must be approved by Revenue.  These are governed by legislation and are required to be offered to all employees on the same basis, many employers don’t feel that these schemes offer sufficient flexibility.

    2.1. Approved Profit Sharing Scheme
    While employees are given beneficial interest in the shares straight away with entitlement to vote or receive dividend, the legal ownership must be held in trust for at least 2 years.  Once granted to the employees they are entitled to retain the shares irrespective

    2.2. Approved Save As You Earn Scheme
    This is a share option scheme where employees agree a savings arrangement for up to €500 per month for defined period.  The are granted an option to purchase a defined number of shares at a fixed price (up to 25% less than market value a the date of such agreement).  At the end of the agreed savings period they can opt to purchase the shares or take the money.

  3. Share types
    It is possible to create a variety of different classes of shares that each have particular entitlements or restrictions in order to achieve a particular purpose for example voting and non-voting or different dividend entitlements.  Depending on how these shares are set up and the price, if any, the employee pays for them, there may be tax savings available.

    3.1. Restricted or ‘Clogged’ shares
    The Employee is allotted the shares at the outset but they are subject to certain restrictions.  This arrangement does give rise to an immediate tax liability for the employee on the value of the benefit received i.e. the difference between the value of the shares and the amount paid for them. However, this is mitigated by virtue of the restrictions that are imposed on the shares.   In order to avail of the favourable tax treatment certain conditions must apply:-

    3.1.1. Share may not be assigned or transferred during the restricted

    3.1.2. The longer the restricted period the greater the abatement on the amount chargeable to income tax (10% per year up to a maximum of 60%);

    3.1.3. The share restrictions must be set out in a written contract;

    3.1.4. Share must be held in a trust established by the employer

    3.1.5. Restriction on the shares must be for bone fide commercial purposes and not tax avoidance.

    3.2. Vesting Shares
    In this arrangement the rights in the shares only vest in the employee in accordance with certain terms and conditions which may be merely the passage of time or be linked to targets or performance.  Depending on how this is structured, the tax liability for the employee may arise on vesting and relate to the value of the shares at that date, which could give rise to the liability being incurred at a future time when the share value is high.

    3.3. Growth Shares
    These usually refer to a separate class of shares with restricted rights which entitle employee to benefit only in the growth of the company thus ring fencing the value already established.

    3.4. Phantom Shares
    While not exactly a share scheme in that the employee is not actually allotted shares, this is a contractual arrangement that entitles the employee to a bonus arrangement that is based on a notional percentage of shares valued as if they were real shares.  Such arrangement is subject to income tax in the normal way

    3.5. Other issues to consider
    Whatever type of shares are allotted other matters to consider include the following:-

    3.5.1. Should a shareholders agreement be put in place?

    3.5.2. Are the shares held by the employee to be subject to good leaver/bad leaver provisions in the event of the employee leaving?

    3.5.3. Does the company have appropriate offer round and tag and drag provisions in place?

If you are considering putting a scheme in place there are a number of preliminary questions to consider:-

  1. Is the scheme to be open to all employees equally or do you want to retain discretion as to the employees who qualify?
  2. Should the employee get the full value of the shares now or is this to be tied in some way to company performance, employee performance and/or employee loyalty?
  3. Are employees entitled to sell shares freely?
  4. What happens to the shares if the employee ceases to be employed with you?
  5. What percentage shareholding will be made available for this purpose?

If you are interested in exploring the options that might be suitable for your company and your employees, please feel free to Elaine McGrath at emcgrath@reddycharlton.ie

Elaine McGrath
Author: Elaine McGrath