Irish tax legislation offers employers a wide variety of ways in which to provide tax-efficient share-based incentives, whether through formal Revenue-approved plans or efficient structuring. Many companies in the industrial engineering sector are taking advantage of these plans. The general position for unapproved plans is set out below, followed by summaries of the various tax-efficient plans for comparison.
UNAPPROVED SHARE OPTION SCHEMES
Unapproved share option schemes remain popular in the Republic of Ireland, because they offer great flexibility in how they are structured. Employers are free to tailor such share option schemes in line with their own corporate philosophy, and to choose which of its executives may participate in such schemes and on what terms. However, the tax consequences for employees can be quite onerous.
Options are usually granted with an exercise price equal to the market value of the company’s shares at the time the option is granted. Exercise of the options may be made conditional on the attainment of performance targets.
For share options capable of exercise within 7 years of grant, no tax arises at grant. Instead, the charge to income tax at 41%, the universal social charge (“USC”) at 7% and employee Pay-Related Social Insurance (“PRSI”) at 4% arises only at the date of exercise of the option. The amount of the gain chargeable to these taxes on exercise is the amount by which:
- the market value of the share(s) at the time of exercise; exceeds
- The aggregate amount or value of the consideration, if any, given for the share(s) and the grant of the share option.
If the option is capable of being exercised after the expiry of 7 years or more following the date of grant, an immediate charge to income tax, USC and employee PRSI may arise at grant. If any tax arises on exercise of the option (on the basis set out above), credit is given against this for any tax paid at the time of grant.
In any event, where the shares appreciate in value between the date of exercise and subsequent disposal, the employee will be liable to account for capital gains tax at a flat rate of 30% on any gain arising on such disposal.
Exemption from employer PRSI
Employers may be able to benefit from an exemption from employer PRSI in respect of unapproved options. Where a bonus is delivered in the form of shares rather than cash, there is an immediate employer’s PRSI saving of 10.75% of the value of the shares delivered.
APPROVED SHARE SCHEMES – TOTAL INCOME TAX RELIEF
Approved Profit Sharing Schemes (“APSS”)
The APSS is the most popular Revenue-approved share plan in the Republic of Ireland. It allows the employer to offer a tax-efficient incentive linked to productivity and profit, while directly involving the employees in the fortunes of the company.
Under an APSS, employees and directors can receive shares with a value of up to €12,700 annually without incurring a liability to income tax. Usually, employees are given the right to convert a profit sharing bonus into shares in their employer company or its parent company.
The APSS is set up within the framework of a trust (see further below for an example in relation to ESOTs), and shares can be awarded to employees free of income tax as at the date of appropriation. The shares must be held in the trust for 3 years for full tax-free status to be maintained. After 3 years, the shares may be sold by the employees free of income tax, USC and employee PRSI. The same exemption from employer PRSI will also apply.
Where the shares appreciate in value between the date they are appropriated to an employee and subsequent disposal, the employee will be liable to account for capital gains tax at a flat rate of 30% on any gain arising on the subsequent disposal.
The main conditions which must be fulfilled in order to obtain tax-advantaged treatment are as follows:
- the trust must be resident in Ireland and must comply with the relevant legislation;
- all employees and full time directors of the company must be eligible to participate in the scheme on “similar terms”. The basis of allocation can vary by reference to remuneration levels, length of service or other similar factors;
- the employer company provides the trust with funds to acquire shares in the company at market value, and the trustees appropriate the shares to employees;
- the limit on the market value of shares that each employee can receive in a year of assessment through an APSS is €12,700;
- the shares must be left with the trustees until the 3rd anniversary of the date the shares were appropriated to the employee.
The employer can generally obtain tax relief on the funds given to the trustees to acquire the shares and the cost of establishing and administrating the scheme.
‘Save As You Earn’ Share Option Schemes (“SAYE”)
On joining a Revenue-approved SAYE scheme, an employee agrees to save a fixed sum out of net pay (minimum €12 and maximum €500 per month) for a fixed period of either 3, 5 or 7 years. The employee is granted share options on the basis of the amount he/she agrees to save. Schemes must use a certified contractual savings scheme provided by a financial institution of 3, 5 or 7 years duration which can give a tax-free return on savings. As with the APSS described above, all employees and full time directors of the company must be eligible to participate in the scheme on “similar terms”.
At the end of the relevant savings period, the employee can choose to:
- use the proceeds to purchase some or all of the shares under option; or
- take the proceeds plus interest earned/bonus as a tax-free cash sum; or
- continue to invest the proceeds with the financial institution.
Options may be granted at a discount of up to 25% of the market value of the shares. The benefit for the employee is that no income tax has to be paid on the grant or exercise of the discounted option. However, the employee will still be liable to account for the USC (7%) and employee PRSI (4%) on the option gain when exercised (although the exemption from employer PRSI will still apply). Capital gains tax (30%) will be chargeable on any gain arising upon the subsequent disposal of the shares.
The costs of establishing the scheme incurred by the employer are generally deductible for corporation tax purposes.
OTHER SHARE SCHEMES – PARTIAL TAX RELIEF
Restricted Share Schemes/“Clog” Schemes
These schemes are similar to the restricted stock plans commonly operated in the US, and can be offered to key employees on a selective basis. Under a restricted share scheme, a participant is given, acquires at a discount or exercises an option to acquire a number of shares in the company or the parent company but a restriction is placed on the shares awarded. The employee must retain the shares for a fixed period (referred to as the ‘clog’ period).
The scheme is established by the creation of a trust which holds the shares for the duration of the clog period. The employee must agree in writing to abide by the clog period and certain other conditions must be met to ensure the shares will be treated as restricted for Revenue purposes.
Because of the restriction on the share sale, the taxable value of the share award can be significantly reduced, depending on the length of the retention period. For example, where the holding period is 5 years or more, the gain chargeable to income tax, the USC and employee PRSI may be abated by 60%. In such cases, the marginal tax, USC and social security charge applied to the share award should fall from 52% (41% + 7% + 4%) to 20.8%. This represents a significant potential saving.
The employee may be liable to account for capital gains tax (30%) on any gain arising on the subsequent disposal of the shares. The abated amount will be used as the base cost when compared with the proceeds of disposal in order to determine whether any gain arises.
The set-up and administration costs and the costs of a share purchase to satisfy a restricted share scheme award assumed by the employer company are generally allowable as a deduction for corporation tax purposes.
Employee Share Ownership Trusts (“ESOT”)
The ESOT is a tax-favoured trust mechanism within which shares can be retained for up to 20 years for distribution to employees (and former employees, within certain limits). An ESOT is usually operated in conjunction with an APSS (see above).
The ESOT is intended to act as a warehouse for the shares which will ultimately be distributed to employees tax-free via an APSS. The transfer of shares from an ESOT to an APSS is generally not a chargeable event for capital gains tax purposes. The APSS is used to afford the employee beneficiary income tax relief on appropriation of shares up to the value of €12,700 in a tax year (as discussed above). The legislation allows the period during which shares are held in an ESOT to count towards the 3 year holding period required by the APSS provided the employee was a beneficiary throughout this period.
The employee beneficiary will be liable to account for capital gains tax on any gain arising on a subsequent disposal of the shares.
The employer company can generally obtain a corporation tax deduction for the costs of setting up an ESOT and for contributions made which are used by the trustees for certain qualifying purposes.
With the prevailing economic climate impacting on share values, now may be an opportune time for organisations to consider implementing or extending employee share incentive arrangements.
Importantly, all employee share schemes established in the Republic of Ireland attract favourable tax treatment from both an employer and/or employee perspective.