What are share incentives and what are the benefits and risks for the employee and company concerned?
Share incentives are the most important means of motivating and retaining staff within a company. Staff and executives were traditionally rewarded with shares in order to align their interests with that of the company shareholders. This often formed a significant portion of the ‘total package’ offered to retain and motivate company executives.
Recent changes in tax legislation have complicated (and reduced) many of the intrinsic benefits of such strategies, however there remain sound reasons for using incentive strategies.
This article introduces share incentive strategies available and summarises the benefits and risks of introducing such a strategy for employee and company alike. Further articles will consider how to implement successful strategies within the current tax and legislative environment.
What are share incentives
Share incentives offer employees the ability to gain financially through any increase in the share price of the company they work for over a period of time. There are various types of incentive schemes such as employee share option plans (ESOP’s), share purchase schemes, phantom schemes, trusts and share bonus plans. Each incentive strategy is characterized by a specific mechanism for rewarding employees and calculating the gain (or loss) accrued to the employee.
For a full list of such schemes email the author for complimentary eBook here.
What are the benefits?
There are numerous benefits of introducing share incentive strategies, including the following:
Improves performance of the business
The company and employee concerned benefit when the performance of the company improves. Companies that have share incentive strategies in place generally outperform those that do not.
Alignment on shareholder and employee interests
Management and shareholders see the business in the same light as they both own a stake in the company.
A mechanism to retain and reward loyal performing employees
Successful companies understand that rewarding loyalty of long-serving employees is in their own best interest.
Creates wealth for employees
Providing access to purchase shares in a company provides an opportunity for staff to create long-term wealth through share ownership.
Tax and cash flow efficient
Certain share incentive strategies were previously tax and cash flow efficient for both the employee and company. Careful consideration of these benefits should be reviewed if your existing share incentive scheme was implemented prior to 2016.
What are the risks related to share incentives?
Delaying the purchase of shares results in the employee “losing out” on the growth of the share value. Employees often don’t have resources to purchase shares in the company they work for which requires loans to staff. These loans are subject to ‘deemed’ interest (for income tax purposes) at the official rate (currently 7.75%) which places the company and staff member at a disadvantage.
Tax treatment of share incentives structures has changed
The profit arising under a share option scheme has always been taxable as income in the hands of an employee, but until recently (2016) the profit arising on a share purchase scheme was treated as a capital gain, taxable at a lower rate. Since 2016, all gains arising under employment-linked share incentives (whether options or share purchases schemes) are taxable as income.
Issuing shares at a discount to fair value is dilutive for existing shareholders and taxable as a fringe benefit. The income tax payable thereon is a monthly deduction for PAYE purposes, the cost of which may not be matched by any dividend payable on the shares. The employee would consider any resultant cash shortfall as a disincentive. In addition, this deemed interest cost to the employee is not an allowable expense for the company.
The technical aspects of taxation related to share incentives are beyond the scope of this article, but essentially all share incentive schemes are subject to income tax whilst qualification for such scheme is linked to employment. Contact the author for further detail on the taxation of share incentives.
Implementation and ongoing management can be complex
The rules and compliance required to implement and manage many schemes can be complex, time consuming and risky for the company and employee concerned. Financing arrangements often require the involvement of external financiers which add a new level of complexity to these transactions.
When determining which strategy to implement, consideration should also be given to the changing nature of the company, financial performance and the inevitable changes in workforce which need to be accommodated by such schemes. Finally, any transactions involving the equity of a company (such a merger or sale) would bring such an incentive plan into the limelight and may form an important part in the transaction.
It is suggested that companies engage the services of an expert in this field to assist in navigating the complex terrain of share incentives.
We have devised a “management buy-in” share structure, which overcomes the tax disadvantages of previous share incentives structures. Contact us if you would like further information.
The next article in this series will cover the technical, tax and cash-flow considerations of successful share incentive schemes.
A complimentary share incentive e-book
If you wish to explore this topic in more detail, please contact the author, Guy Addison for a complimentary e-book that covers an introduction to shares incentive strategies, benefits, types, risks and implementation.