Your client cannot afford to make the customary inflation-linked increases to staff salaries this year. However, they are keen to reward their employees in some way. Why might a share incentive plan be a good alternative?
Employment-related securities
You may find increasing salaries difficult at the moment. A mix of the pandemic and soaring overhead costs means that cash is at a premium. However, there are other ways to reward loyal staff. One alternative would be to set up a share reward scheme.
Pro advice. Shares provided “by reason of employment” are subject to the employment- related securities regime. Among other things, this means that shares provided free, or at undervalue, can trigger an income tax charge. However, there are “tax advantaged” schemes that can avoid punitive charges.
Tax advantaged
There are a number of schemes that the government permits to enjoy certain tax benefits. Which of these is best for you will depend on your circumstances. Here, we will consider the share incentive plan (SIP) . This is an “all employee” plan, meaning that it must be open to all employees on similar terms. As a result, it may be an ideal solution for those looking to provide non-cash rewards.
By using a SIP, an employer can provide shares to its employees either at no cost to the employee or potentially at a price below market value. Shares are awarded to employees and put into a trust where they remain until the employee withdraws them. Provided the shares remain in the trust for a minimum of three years, favourable tax treatment is available when they are removed.
Once established, further planning may be undertaken to set up an internal market, e.g. an employment benefit trust, so the share value may be realised by the employees.
There are four methods of providing shares to employees under a SIP:
- Free shares.
- Partnership shares.
- Matching shares.
- Dividend shares.
Free shares
As the name suggests, free shares are given to the employee for no charge. A company can award up to £3,600 of free shares to each employee in each tax year. The company must set a minimum holding period of three to five years following the award. In the absence of the SIP, this award of free shares would normally mean the employee incurs a tax charge as if the share were earnings. However, under a SIP there is no charge, as long as the limits are observed.
All employees must be entitled to participate; however, the company can provide differing numbers of shares to employees based on their income, length of service, hours worked or meeting performance targets.
Pro advice. These adjustments may not be used to create an entitlement of nil.
Example. Bob is provided with 100 shares in his employing company. The shares are valued at £10 each. Bob therefore receives £1,000 of shares tax free.
Partnership shares
Partnership shares are purchased by employees from their pre-tax and NI salary. A fixed amount is taken each pay period, up to a maximum of £1,800 per annum or 10% of salary if lower; these limits can be reduced by the employer. This money is then used to purchase shares by the trust, either immediately or following an accumulation period.
Pro advice. Care must be taken to ensure the reduction in salary does not affect any state benefits received by the employee.
Pro advice. An accumulation period is optional and cannot exceed twelve months.
If an accumulation period is used, the company and employee can agree beforehand that the shares will be awarded based on the market value of the shares at either the start or end of the period (or whichever is lower).
The funds must be used within 30 days of the end of the accumulation period or the final payment in the period.
Example. Bob agrees that his employer can deduct £100 per month from his basic rate salary. His tax and NI deductions fall by £32 per month so his net pay falls by £68 per month. At the end of the annual accumulation period the company shares have increased from £10 to £16 per share. His employer opts to use the market value at the start of the year as the purchase price, therefore Bob receives 120 shares currently worth £1,920 in exchange for net payments totalling £816. Even if the share price had remained unchanged, Bob’s shares would still have been worth £1,200.
Matching shares
Where partnership shares are acquired by an employee, the employer can match these shares up to a ratio of two matching shares for each partnership share. These shares must be identical to and awarded on the same day as the partnership shares in question. Matching shares must be offered on the exact same basis for all participating employees.
The company must specify a holding period of between three and five years, starting at the date of award.
Example. Bob is given two further shares for each of his partnership shares. He therefore receives an extra 240 shares worth £3,840.
Dividend shares
Generally, any dividends paid on shares held within the SIP will be paid to the employee. However, the company can require that a proportion of any cash dividends are instead used to acquire further SIP shares. Any such reinvested dividends are tax free.
These dividend shares must be identical to the shares on which the dividends were paid and must be acquired within 30 days of the dividend payment. Where a surplus remains after acquiring new shares, this can be rolled over and used to purchase shares in the following period while still remaining free of dividend taxes.
Dividend shares must be held for at least three years from acquisition.
Example. Bob’s SIP shares generate a dividend of £500 and he receives £2,000 from other companies. The share price at the date of the dividend is £25, therefore Bob receives 20 shares worth £500 for £462.50.
Pro advice. In total Bob has acquired shares worth £7,260 while paying just £1,279.
Pro advice. There are tax advantages for the employer as well. The cost of setting up and administering an SIP is deductible for corporation tax purposes. Similarly, any amounts incurred by the company to purchase the shares, including the difference between market values for partnership shares (i.e. in Bob’s case, £6), can be deducted from taxable profits.
Potential tax traps
If the shares remain within the SIP for five years, they can be removed completely tax free. If the shares are removed after three years but before five, any dividend shares remain tax free. However, any other SIP shares will be subject to tax. The value used is the lower of the market value of the shares at removal and the market value/salary used to acquire the shares initially.
If the shares are removed within three years, any dividend shares will be taxed as if the related dividend had been paid to the employee on removal. All other shares will be taxed based on their market value at removal. Where the shares are readily convertible assets, tax and NI is deductible by the employer. For all other shares, tax is payable via a tax return.
Guidance on setting up and administering a SIP can be found at ETASSUM20000.
A share incentive plan is an all-employee share scheme that allows you to reward employees with free, or very cheap, shares with no income tax consequences. Once awarded, ensure the employees hold the shares for the minimum specified periods (five years for most types) in order to preserve the tax-free status.
The next step
HMRC Guidance: ETASSUM20000
HMRC Guidance: Employment Related Securities
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.