Using share schemes to attract and retain employees

Share schemes are not just for multinationals – they can also offer an ideal employee reward solution for smaller Irish companies seeking to attract and retain employees with key skills. Savvy employees are aware of the benefits available in the marketplace and have expectations that go beyond the basic salary.

The key challenge for small, medium and start-up employers is competing financially with large companies operating in Ireland when it comes to attracting and retaining staff. Share-based remuneration offers an ideal solution as the initial cash cost is generally modest while ensuring that employees are rewarded for their contribution to business growth.

Offering employees a stake in the company through share-based remuneration increases commitment and motivation and leads to higher profits. Employee ownership can help to resolve issues such as high staff turnover and retain key individuals within the business. Employers will also benefit from a PRSI saving associated with the share-based remuneration it offers to employees.

Irish tax rules provide several options in designing attractive and workable share schemes. When choosing a scheme, employers and their employees should be clear on their understanding of the objectives of the scheme, whether it is to retain key employees for the long term, reward employees for past performance or allow key employees to share in the proceeds from a possible sale of the company in the near to medium term. A company can introduce multiple schemes aimed at different categories of employees.

Below is an overview of some common share-based schemes currently available in Ireland: 

1. Key Employee Engagement Programme (KEEP)

KEEP was introduced in 2018 to support growing businesses in recruiting and retaining key employees and is aimed at encouraging SME employers to offer share options as a reward for staff.

Qualifying options granted under the KEEP scheme are not subject to income tax, USC or PRSI on exercise of the option. Capital gains tax will apply on the disposal of the shares where their value has risen since the date of grant.

Currently, many businesses are precluded from participating in the KEEP scheme due to restrictive conditions. Financial services companies are currently listed as ineligible, which precludes many fintech companies from participating. Legislation was amended to allow holding companies in a group to qualify for the scheme, but difficulties arise for companies where the holding company is trading. Start-ups often have a subsidiary in a foreign jurisdiction, which could also disqualify them from being a qualifying group structure. For these reasons, the uptake of the KEEP scheme has been lower than anticipated. However, it should not be dismissed by SME employers when considering their options for rewarding employees as it can work quite well for many organisations. 

2. Stock options

A stock option is an option granted to an employee to subscribe for shares in a company at a predetermined price in the future. Generally, the employee will be expected to complete a certain period of service with the company before being capable of exercising the option. The employee does not have any rights relating to the shares until the option is exercised.

Options are often popular due to their simplicity and international recognition. All tax obligations/risks on exercise are with the employee, as the company has no responsibility for operating any payroll taxes on the exercise of an option. Options are also not subject to employer’s PRSI.

On exercise of the shares, employees may need to sell some of the shares immediately in order to fund the acquisition and the associated taxes; this can often be difficult to achieve in the case of private companies where there is no readily available market for the shares. This is a difficulty with most share schemes in SMEs. In addition, valuing the shares in a private company may prove difficult. 

On a disposal, the value of the shares subject to income tax at the time of exercise can be added to the base cost of the shares. Capital gains tax at a rate of 33% will apply to any appreciation in value. 

3. Restricted shares (clog scheme) 

When an employee receives an award of shares for free, a taxable benefit arises for the employee on which income tax is payable. However, a reduction in the taxable value is allowed where a restriction on the right to dispose of the shares is put in place by their employer. The period of restriction is often referred to as a “clog” period, hence the name of the scheme. Provided certain conditions are met, a reduction in the taxable value of up to 60% can be achieved where the restriction is enforced for more than five years. For shorter periods of restriction, the percentage reduction declines. 

Restricted share awards are most suitable for a company that wishes to give free shares to its employees and has shares with a relatively low value or wishes to reduce the cost further with a clog. It is often appropriate for a company that cannot issue multiple classes of shares and therefore cannot issue growth/hurdle shares. 

Restricted share awards are not subject to employer’s PRSI. The employer is responsible for withholding income tax, USC and PRSI on restricted share awards via payroll. This up-front tax charge may not be attractive to employees, as the shares cannot be disposed of to fund the tax cost for the duration of the clog period. Nonetheless these schemes have proved very popular in the SME sector. 

A clawback of the abatement will occur if the original restriction is removed or varied during the clog period and any additional income tax will be due. 

On a disposal, the employee is subject to capital gains tax on any uplift in value. 

4. Forfeitable shares

Forfeitable shares are shares linked to growth targets of the company. If growth targets are achieved, the individual will retain the shares. If the targets are not met, the individual will forfeit their shares and will cease to hold any beneficial interest in the shares. 

Forfeitable shares are usually given to an employee either free or at undervalue. A charge to tax will arise on the difference between the price paid by the individual and the market value of the shares, ignoring any forfeiture provisions. Employer’s PRSI should not be payable.

Where shares are subsequently forfeited, the individual can seek a refund from Irish Revenue of the amount of tax paid on acquisition. If the targets are met and the shares do not become forfeitable, the individual can keep their shares. 

Any increase in value of the shares from the date of acquisition is subject to capital gains tax on disposal. 

5. Growth shares

Another type of share which has become very popular with SMEs are “growth” or “hurdle” shares, as the cost associated with awarding such shares is minimal. Growth or hurdle shares are a separate class of ordinary shares which participate in the future hopeful value of the company and usually have no rights to the current value of the business. The shares are often subject to performance hurdles or targets which the company must meet before the employees’ shares have any entitlement to the value of the company. The existing shareholders retain the value already built up in the business. 

The employer must withhold tax and PRSI on the difference between the price paid to acquire the shares and the market value of the shares on acquisition. Employer’s PRSI should not apply. The increase in the value of the shares from acquisition will be subject to capital gains tax on disposal. The market value of the shares is often quite low initially as no existing value is being passed to the employee due to the targets which have been set. 

Growth or hurdle shares may be difficult to value as the rights of the shares are different to ordinary shares and their value is the future hopeful value.

6. Phantom shares

A phantom share scheme or stock appreciation right (SAR) is where an employee is entitled to participate in the growth in the value of the company but receives cash remuneration rather than actual shares in the company. The employee is given a notional quantity of shares and if the value of the shares in the company increases over a period of time, the employee will be entitled to a cash bonus equivalent to the value of the increase in the shares. 

An employer will often impose conditions to be met by an employee to participate in these schemes. The employer may entitle an employee to benefit from any dividend policy declared by the company by way of a cash bonus.

Any benefits paid to an employee under a phantom share scheme or stock appreciation right will be liable to income tax, USC and PRSI. These are also popular in the SME sector as there is no upfront tax cost and the founding shareholders are not required to give away any of their initial shareholding. 

Valuation

Once you have chosen the scheme most suitable to your organisation, you will need to establish the value of the company for tax purposes. We recommend engaging with a professional to obtain an independent valuation of your company in advance of implementing any of the above schemes to ensure that any shares issued have been valued correctly and to mitigate the PAYE/interest/penalties risk for the employer.

If you would like assistance in developing an employee incentive scheme for your business, please contact a member of our tax team.