Reviewing your reward strategy - delivering benefits at a lower cost and in a tax efficient manner

Approved Profit Sharing Schemes

By Gearóid Deegan
First published in  Irish ProShare Association (IPSA) Newsletter
January 2010
Reproduced by permission

As we move into 2010 with the prospect of a gradual turnaround in the economy, many employers impacted by the recession are looking at ways to keep their remaining workforce engaged and motivated. The use of progressive reward strategies which will underpin the business drivers going forward can be an effective tool to achieve these goals. In this regard, consideration should be given to using the incentives which the tax system facilitates and a Revenue Approved Profit Sharing Scheme (APSS) is a case in point.

An APSS is a tax efficient means of distributing “profits” in the form of shares to employees. Taken further, it can also be structured as a mechanism for motivating employees and giving them the opportunity to take a stake in the company’s future. The typical APSS structure would offer employees a choice of receiving tax-free shares as an alternative to a taxable cash bonus payment.

When might an APSS be used?
The term “profit sharing scheme” can be somewhat misleading, as it generally does not involve the distribution of “profits” in the form of “free shares” to employees. The reality is that most APSS arrangements are funded by way of a discretionary bonus arrangement. Examples of situations where a company might consider using an APSS would include:

  • Once off or irregular distribution of free shares to employees to mark a particular milestone or
  • achievement in an organisation’s development e.g. an IPO;
  • In conjunction with a costed and verified transformation programme i.e. through a self funding mechanism;
  • As part of a structured “gainsharing” arrangement;
  • In substitution for, or as part of, a performance related cash bonus arrangement, which could include corporate performance criteria;
  • In conjunction with a bonus arrangement incorporating both corporate and personal appraisal objectives; or
  • As part of a pure discretionary bonus arrangement.

What are the benefits for employers?
It is generally accepted internationally that organisations which implement effective employee share participation arrangements outperform those organisations which do not. In the context of a properly structured APSS the benefits to the company can include greater employee engagement and flexibility, increased productivity and improved communications.

Under current rules share based remuneration does not generally attract a charge to employers’ PRSI. This can lead to savings close on 11% of the aggregate value of shares delivered, as compared to cash bonus arrangements.

What are the benefits for employees?
An APSS can be used as a mechanism to offer employees an equity stake in the company which in turn can reinforce increased awareness of the link as between performance and reward. At a time when share values are generally somewhat depressed, there is even more potential upside for the employees in terms of future capital appreciation.

Under current rules shares delivered through an APSS are not liable to income tax, the income levy, or the health contribution. As a result the after tax benefit is considerably more favourable than a pure cash payment which would be fully taxable.

What is “salary forgone” in the context of APSS?
Where an employee elects to take shares through an APSS, they can be offered an additional facility to topup this employer’s contribution by way of salary forgone. In other words, they can match the employer’s contribution and purchase further shares from gross income in a tax efficient manner. There is no additional cost to the employer for this facility and indeed there could be a further saving in employer’s PRSI.

What limitations apply?
The aggregate value of shares which may be delivered to an employee under an APSS is €12,700 per annum. The employee salary forgone contribution cannot exceed the amount of the employer’s contribution taken in shares, or 7.5% of basic salary if less.

What are the key features of an APSS?
While there are a variety of formalities required in relation to an APSS, these are now well established and, in general, easily addressed. Some key requirements in relation to establishing an APSS would include:

  • The ability to offer employees shares in the employing company or parent company;
  • All employees must be eligible to participate, subject to a minimum service requirement;
  • All eligible employees must participate on “similar terms”;
  • Where a bonus arrangement is to be used to fund the share acquisition it must be discretionary in nature and not fixed or contractual;
  • The scheme must be established within the framework of a trust and prior Revenue approval is required.

Conclusion
APSS represent a very generous tax incentive which can be combined with robust performance related criteria that support the business drivers, delivering benefits for the company, the wider shareholder base and employees. It should be actively considered as part of any overall review of future reward strategy.