Restricted Share Awards or “Clogged Shares” are shares awarded to employees where the employee owns the shares up-front, but is restricted from dealing in them for a period of time. These awards have tended to be less popular in Ireland than share options to date, due to the up-front tax charge that such awards incur. However, a restricted share award is the only share incentive in Ireland that qualifies for statutory tax savings and can be operated on a selective basis by companies i.e. it does not have to be awarded on an all-employee basis. In addition, the fact that many share values are currently depressed as a result of the recession means that an up-front income tax charge may be advantageous, as the tax charge will apply to a relatively low value and any future rises in the value of the shares will come within the - much lower - charge to capital gains tax instead.
Reducing the Up-Front Tax Charge
Since 2008 the tax treatment of restricted shares has been given a statutory basis, providing greater certainty for employers that the favourable tax treatment that such awards attract will be available to them, provided certain conditions are met. Previously, it was necessary to rely on a Revenue concession.
In general, an award of shares for which the employee pays less than their market value (or if he/she receives them for free) will be a taxable benefit, and the full value of the shares, less any amount paid towards the cost, will be subject to both income tax, the Universal Social Charge (USC) and employee PRSI. However, where the employee cannot deal in or dispose of the shares for a period of time, there is scope to reduce the taxable value of the shares by 10% per year of the restriction (the maximum reduction is set at 60% for a restriction of over 5 years), provided the conditions set out below are met.
As with all incentives delivering shares in the employer or its parent company, restricted shares are also currently exempt from employer social security charges, which (at present rates) is a significant tax saving for companies.
If an employee is awarded newly-issued shares worth €10,000, which are restricted for 3 years, the taxable value can be reduced by 30% so that he/she will only be subject to income tax, USC and PRSI on €7,000 at the outset. If they have risen in value to €12,000 when he/she disposes of them after the end of the 3 year period, the gain of €5,000 is subject to capital gains tax.
When compared to the cash equivalent, or a nil-cost stock option which is exercised after 3 years when the value is €12,000, the tax savings are as follows: (Assume: 41% income tax, 7% USC and employee PRSI at 4%)
Click here to view table.
Conditions for Favourable Tax Treatment
- In order for a restricted share award to qualify for favourable tax treatment it must meet certain specified conditions, for example:
- The restriction must be contained in a written contract.
- The contract must be in place for bona fide purposes, not for tax avoidance purposes.
- The shares cannot be assigned, transferred, etc during the restricted period (except on death or in the event of a corporate transaction).
- The shares must be held in a trust established by the employer in Ireland or the EEA (with trustees who are resident in Ireland or another EEA state), or under other arrangements approved by the Irish Revenue Commissioners.
- There is no requirement to obtain Revenue approval in advance for an arrangement which meets the above criteria.
Tax Payment and Reporting Obligations
Since 1 January 2011, the employer is responsible for withholding income tax, USC and PRSI on restricted share awards via payroll.
Restricted shares offer a tax-efficient alternative to stock options, restricted stock units and other share-based awards, as well as cash bonuses.
The up-front income tax, USC and PRSI charges may not be attractive to some employees, given that none of the value of the award can be realised to fund the tax cost for the duration of the restricted period. In addition, restricted share schemes may not be suitable for companies experiencing share price volatility. However, realising income now, when a company’s share price may be relatively low, so that any subsequent gains fall into the capital gains tax regime, may make good sense for others and when added to the scope to reduce the income tax, USC and PRSI charge, has the potential to produce a beneficial tax result overall.
From the employer’s perspective, a restricted award is an effective incentive tool. In addition, unlike stock options, a restricted share award delivers value to the employee at the outset and will align his/her interests with those of shareholders.