- 19 March 2017
- Posted by: Paul Keane
- Categories: Commercial Law, Corporate Transactions, Employment Law
Employee Shares Schemes – An Update
Employee Share Schemes
In the current economic climate many employers are looking at non-remuneration- based incentives that have a low cost and give some additional incentive and benefits to employees to participate in the company. Employee Share Schemes would fall into these categories of incentives.
Employee Share Ownership Trusts
These were established historically in Ireland to give employees an interest in the company and a mechanism to participate in any subsequent sale of the companies at a later date.
The basic structure is that a trust is established to house the shares and the shares are subsequently distributed tax-free once they have been placed in the trust for a specified period of time.
Setting up the trust is a tax deductible cost for the Company that establishes it and both employees and employers can contribute to the trust.
- The Trust can borrow money and it can earn dividends in its own name.
- There is a requirement that the company establishing the trust must not be under the control of another company.
- The trust must be accessible to all employees on equal terms.
- There are also specific application formats and compliance obligations.
- To qualify for the income tax relief upon the distribution of the shares, the shares must be held in the trust for a period of three years.
- When the employee ultimately disposes of the shares then CGT will apply on this disposal at the normal rates.
Once all the conditions are met, an application is made to the Revenue and the trust is established and is listed on the Revenue list of approved ESOT schemes and shares can be apportioned to the employees with no income tax charge.
Revenue Approved Share Option Schemes
Revenue Approved Share Option Schemes have been abolished since 24 November 2010, which means that no approved options can be granted after that date. For options granted before that date but exercised after 1 January 2011, the revised tax treatment introduced by the 2011 Finance Act (below) applies.
Unapproved Share Option Schemes
Grant of an Option: This is where an employee acquires a right to purchase shares at a set price which may or may not be market vale. Generally this has no income tax consequences unless the right is capable of being exercised more than seven years in the future (rare in practice) in which case a charge to income tax may arise on the grant.
Exercise of an Option: Where the employee exercises the right that has been granted as above. Income tax is chargeable on the difference, if any, between the market value of the shares at the exercise and the exercise price afforded to an employee.
Where an employee is granted unapproved share options by reason of an employment, a charge to income tax will arise when the employee takes possession of the shares, irrespective of whether or not the employee retains or sells the shares.
The charge to income tax will be the excess of the market value of the share on exercise over the option price and this share option gain will be taxable at the employee’s marginal rate of tax. This is effectively taxing the benefit in the employee’s hands.
The income tax & USC arising on the taxable benefit is payable within 30 days by way of an RTSO1 Form.
When the employee then subsequently disposes of the shares, the amount that was chargeable to income tax becomes part of the consideration paid for CGT purposes.
As an example:-
In 2008 an Employer grants an unapproved share option which is valid for five years. The option price payable on exercise is €2,000. The employee exercises the option in 2012 when the shares are worth €5,000. The employee thus pays €2,000 under the terms of the grant of the option. The €3,000 difference is assessed to Income Tax in 2012 as the taxable benefit or undervalue. The employee is the assessable person and must file a tax return for this period. There is an option to defer this income tax providing certain conditions are met:-
- The shares are not disposed of in the same year
- Proper returns are made
- The election to defer is applied for.
The logic of such a deferral is to ensure that employees are not hit with a charge to income tax where they may have no assets to meet such a charge on the mere exercise of the option.
When the employee disposes of the shares at a future date this disposal will give rise to a Capital Gains Tax on the gain that may have accrued between the date of the exercise and the date the shares were disposed of. The income tax previously charged at the date of grant is included in the base cost of the disposal gain calculation for CGT purposes reducing the amount of the gain assessed to CGT. Thus in our example he base cost of the disposal is the €2,000 actually paid PLUS the €3,000 which was assessed to income tax by the employee.
Restriction on Disposal of Shares
There is an abatement or reduction from the initial charge to income tax if there are restrictions on disposal after the option is exercised. If the employee is barred by written terms from disposing of the shares for a number of years, a reduction is applied in the amount assessed to income tax. These are known as ‘clogged shares’.
No. of years of restriction on sale Abatement
1 Year 10%
2 Years 20%
3 Years 30%
4 Years 40%
5 Years 50%
Over 5 Years 55%
When the employee ultimately disposes of the shares the actual abated cost charged to income taxes is included in the base cost and not the amount that would have been assessed without the abatement. So using the same figures in the above example, if there was a restriction on the disposal of the shares for 4 years the amount assessed to income tax would be €3,000 X 30% = €900 and that is the amount included in the base cost for a subsequent disposal.
Where goods are exchanged, the assessable date for CGT is usually the date that contract is signed, as the actual title passes on this date. In the case of a share award being contingent on a condition, the date that is assessed for CGT purposes is the date that condition is satisfied.
Restricted Stock Units
A restricted stock unit is a grant or a promise to an employee that upon completion of a “vesting period”, he/ she will receive a number of shares or cash to the value of a number of shares. A restricted stock unit is generally evidenced by way of a certificate of such entitlement.
Revenue have indicated that a RSU is not a share option as outlined above but is chargeable to income tax as a emolument or pay in respect of an employees office.
Where the shares are in the employment company or an associated company they will not be subject to PAYE provisions but where they are shares in a non connected company they will be within the scope to PAYE and will need to be treated in the normal manner.
Finance Act 2011 clarified that USC is chargeable on all Restricted Stock Units (see below).
‘Clawback’ of Forfeitable Shares on Leaving Employment
Shares will be forfeitable shares if there is a contractual clawback if the employee leaves the company and if certain circumstances do or do not arise.
When the shares are granted they are treated as normal for income tax purposes but if they are subsequently clawed back an adjustment is made to refund the income tax paid as if they had never been granted.
The Finance Act 2012 outlines that the USC will also be refunded in these circumstances.
If the holders of shares receive additional bonus shares granted at a later date the additional shares will assume the same date of acquisition as the original shares granted and the CGT base cost will need to be adjusted to take account of the additional appropriation.
Finance Act 2011 changes
The Finance Act 2011 fundamentally changed the basis of taxation of all share schemes. The following share schemes have been brought within the charge to the Universal Social Charge, as well as subjecting the Shares to Employers PRSI.
- Share awards
- Unapproved share options
- Revenue approved profit sharing schemes
- Approved save as you earn schemes
- Approved share option plans
- With effect from 1 January 2011 employers will be obliged to operate PAYE, PRSI and the USC in respect of share awards received by employees. It has been confirmed through a series of Ministerial announcements that no employer PRSI charge will arise on share based remuneration.
Finance Act 2012 changes
The Finance Act 2012 brought introduced some clarifying provisions particularly in relation to forfeited shares.
- Where income tax has been deferred (as outlined above in the example) FA 2012 outlines that on any subsequent disposal of the shares half the gains (after tax) must go to pay down the deferred income tax liability until it is fully discharged.
- Where an employee does not discharge the Income tax due on a share award the employer may withhold or sell a portion of the shares to discharge this liability.
- Where shares are forfeited the USC and PRSI deducted will be refunded.
If you have any queries in relation to the above topic, please contact Paul Keane at +353 1 6619500 or firstname.lastname@example.org.