Extracting more value from your share schemes

This article first appeared in Accountancy Ireland, October 2011.

Pat Mahon believes many companies would benefit from a review of their current share plan strategy.

In a recent PwC survey, 83% of Irish based CEOs stated they will focus on strategies for managing talent over the next 12 months, with reward structures playing a key part in their review. As 2012 approaches, businesses need to look to the future and to position the organisation for opportunities that lie ahead. Employers who stay current with the best packages on offer will be more likely to retain and/or attract the best people in their industry.

At the same time, significant tax increases for employees have put more pressure on businesses to maximise the tax efficiency of what they can deliver to staff. Furthermore, many employee benefits no longer qualify for tax relief or have suffered a significant drop in the value of relief available. Against that backdrop, many companies are reviewing their share incentive plan arrangements to see if they can:

Take advantage of the employer PRSI exemption
Maximise available tax reliefs for employees
Increase employee engagement
Be more efficient in linking share awards to relevant business performance targets
Be compatible with evolving shareholder demands (e.g. forfeiture, deferral)
Ensure they are competitive in the market so as to attract/retain new talent

Some companies are also looking at historically low share prices in their sector and considering whether, assuming the market rises, this might present an opportunity to firmly lock in staff conirnitrnent to the organisation onee share value appreciation takes hold. It is timely to reflect on some potential solutions that might assist organisations deliver on this key CEO agenda item for 2011/12.

Employer PRSI exemption

A share scheme benefit is one of the few forms of remuneration which avoids the 10.75% employer PRSI charge. The exemption applies to all share plans so long as the shares are in the employing organisation or a company controlling the employer. Whilst mere has been widespread confusion on the new PRSI charges introduced from 1 January 2011, the Minister for Finance has now been unequivocal in his support for an employer PPvSI exemption stating that such a charge "...would have the potential to negatively affect current employment levels and future investment decisions. . .". With that rationale in print, it is difficult to see the Minister rolling back on this viewpoint in Budget 2012 so we can now expect this relief to continue for the foreseeable future. This is good news for companies with subsisting awards but also for those who plan to increase share plan awards in the coming years.

Employee PRSI

The employee PRSI position on share awards was re-clarified by the Minister for Social Protection on 23 August 2011, as follows:

Employee PRSI will apply to all share awards or share option gains crystallising on or after 1 January 2012
The grandfathering provisions, announced originally in March 2011, will now only apply to share awards or share option gains crystallising in 2011. The underlying awards must have been evidenced in writing before 1 January 201 1 to avoid employee PRSI in 2011

In essence, individuals who are in position to exercise subsisting options or to receive shares on foot of pre-201 1 awards/grants have a window of opportunity until 31 December 201 1 in which to avoid a 4% employee PRSI exposure.

Tax savings for employees

There are a number of different share plan structures possible depending on what the particular requirements might be. However, in the context of tax reliefs available to employees, two plans stand out.

For senior management, Restricted Shares are overtaking share options to be the most efficient solution for companies for a number of reasons not just tax related (e.g. different accounting treatment and negative experiences with underwater share options in recent years). Importantly though, Restricted Shares do offer the prospect of very favourable tax reliefs in Ireland.

There are certain broad principles that must be integrated into any plan so as to ensure tax reliefs are available and it is critical that all these elements are reflected in the scheme documentation. The tax relief is available at the point beneficial ownership of the shares transfers to the employee and the relief largely hinges on whether the company makes the award subject to an absolute clog or restriction on disposal. Each year of restriction can deliver a 10% abatement on the taxable amount with a maximum abatement of 60% for restrictions greater than five years. Using a simple example of shares worth euro10,000 delivered to an employee today with a 3-year restriction on sale, the employee will suffer payroll taxes on euro7,000 today (income tax, the universal social charge and potentially employee PRSI). The only subsequent tax charge would be Capital Gains Tax (CGT) if the shares are sold at a price in excess of euro7,000.

For executives, this arrangement represents one of the few remaining opportunities to reduce income tax charges for executives in particular. Whilst participants must fund their liabilities (collected through the PAYE system) on the acquisition of the Restricted Shares without recourse to the underlying asset, there are opportunities to link these awards to relevant business targets including forfeiture or clawback conditions which can in turn ensure tax paid upfront is refundable if forfeiture occurs.

Historically, many overseas headquartered organisations offered share plans to subsidiaries globally on the same basis regardless of local tax rules. Increasingly, those companies are now moving to more flexible share plans rules which offer a range of different instruments.This can present an opportunity for Irish subsidiaries to seek the award that will deliver the most tax efficient answer for staff based here. In many such cases, particularly for senior executives, that answer is likely to be Restricted Shares.

When looking at incentivising staff below senior management, a Revenue Approved Profit Sharing Scheme (APSS) is a means of distributing shares to all staff free of income tax. A typical structure used by many companies is to offer employees a choice of receiving shares as an alternative to discretionary cash bonuses. Other features include:

Employees can acquire the shares free of income tax (up to euro12,700 per annum)
Shares must be held in a trust for three years
Revenue will now accept bonus plans which deliver rewards by reference to individual performance
APSSs must be available to all employees on similar terms
A 'salary foregoing' feature can significandy augment tax reliefs

Over 500 APSSs have been approved by the Irish Revenue Commissioners. It remains the most popular share scheme amongst employees in Ireland. Furthermore, there are opportunities for those with an existing APSS to take a closer look at how they operate the plan to see if it can be made more efficient for the business.This might involve introducing, subject to Revenue approval, an individual performance condition. Also, for many Irish subsidiaries with parent companies listed overseas, uncertainty over internal approval processes can sometimes dissuade Irish management pursuing internal approval for an APSS. However, there are many examples of Irish subsidiaries of overseas parent companies introducing APSSs. This is strengthening the case for others to follow suit.

Using share plans effectively

The underlying aim for most shareholders, when approving share plans, is to better align the interests of management with those of shareholders themselves. Whilst this is usually the starting point when establishing targets within incentive plans, effective plans will consider these needs in conjunction with other relevant factors, including:

Understanding what goals are more likely to motivate the share plan participants such that behaviour is actually influenced
The targets being achievable and seen to be so
The avoidance of complexity and ambiguity as both tend to be unpopular with participants

In strong organisations, the over-riding principle in looking at share-based reward structures is to develop targets consistent with the key goals of the organisation.Whibt the tax result is particularly important today, shareholders will be predominantly focussed on adopting the right plan for the right people where the appropriate risk/ reward balance for all stakeholders is maintained. That can usually be achieved without compromising the tax opportunities.

Reminder: New tax obligations for companies

In looking to instigate changes, or indeed when reviewing existing arrangements, it is worth investing some time to ensure your *organisation is up to date on the new tax rules. In particular, PAYE withholding has been introduced with effect from 1 January 201 1 for share awards (not share options) and penalties will apply for organisations who fail to implement the new procedures.

Further guidance on this evolving issue, including regularly updated bulletins on the latest developments as they emerge, is available at www.pwc.com/ie/sharebasedreward