Why it makes sense to give staff a stake in firms
I have recently come across two situations that demonstrated why it may make sense to grant shares to employees. There are probably many others.
The first concerned an entrepreneur who wanted to build up his company and sell it within five years. Granting employees a stake in the business now meant that they had a vested interest in ensuring the value of the company would be maximised when it came to it being sold.
The second situation related to business succession. The owners of the company wanted to pass their shares to their children in their wills. However, none of the children were active in the business.
The solution was to grant shares to key personnel in the company. When the owners eventually died, those personnel would be given a degree of autonomy in running the business. In that way, the personnel have a vested interest in the success of the business, and the value of the shares inherited by the children would be maximised.
So, what type of scheme should be used?
To start with, share schemes may be approved or unapproved. An approved scheme is one that has been approved by the Revenue Commissioners.
Under such schemes, employees receive tax relief for acquiring shares -- their taxable income is reduced by the amount invested. There are conditions attached -- for example, under an Approved Profit Sharing Scheme the shares must be held in limbo for three years before the employee can sell them.
While the tax relief is attractive, there are difficulties with approved schemes. Revenue approval and administration can take time and, therefore, can cost money. Also, they must be made available to all employees equally.
This means that those who operate on a work-to-rule basis will have the same entitlement as someone who puts their heart and soul into the job.
Unapproved schemes do not attract the same tax relief but they do offer an employer flexibility regarding who they wish to reward. Ordinarily, if shares are granted to an employee at less than market value, the employee will be subject to tax on the difference.
However, if a restriction is put on the shares so that they cannot be transferred for a number of years, the tax payable can be reduced by up to 60pc. Also, tax is based on the market value of the shares and, given our current economic woes, market values may never be lower. When they are eventually sold, any future growth in the value of the shares would be subject to capital gains tax.
An alternative to granting shares would be to grant options. If you hold an option, you have the right to purchase the share but you do not own the share itself.
Options are useful in that, generally, employees need not cough up money or pay tax at the time they are granted. For example, an option could be granted now but would be exercisable on the sale of a company.
In such a case, the option would be exercised and the shares sold immediately. Continuing the example, the employee would receive the uplift in value from the date of grant to the date of exercise.
That uplift would be liable to income tax and this may be seen as a disadvantage. Another disadvantage of options is that the employee does not acquire voting rights. So they may not suit the business succession situation mentioned above.
The fact that shares are themselves an abstract concept means that the various scheme types can appear convoluted to employees and that, in turn, can lead to mistrust. So it is important to be as clear as possible when introducing a share scheme. If its purpose is to increase loyalty and enhance the value of the business then the employer should say as much.
The common thread in all of the share schemes is that there are tax implications. Advice from a suitably qualified (and insured) professional should always be obtained a) before implementing a scheme, and b) when shares are disposed of.
Paul Brady is a registered tax consultant, a barrister and founder of TaxandLegal.ie. He can be reached at email@example.com