Stability and succession
The challenge of a global pandemic has emphasised the importance of a stable workforce. Many businesses are evaluating how to create a rewarding workplace which maximises staff retention. Added to this, the baby boomer generation is starting to look at how to exit from their businesses completely. This is giving rise to an increase in the number of employee share scheme (ESS) arrangements being put in place. Not only do employees feel rewarded and more connected to the company, they are encouraged to grow the value of their shares. While ESS schemes do have positive aspects for rewarding staff and maximising employee retention, the income tax implications are complex and need to be considered prior to implementing any scheme to ensure both parties are aware of their obligations.
Most people will have a natural expectation that gains on shares will be non-taxable, whilst income from employment, such as salary, wages and cash bonuses will be taxable. However, the current ESS regime was designed to tax the two in the same way. Therein lies the problem - it comes as a surprise if the shares are taxable. Shares under an ESS arrangement are generally not caught for income tax purposes if: 1- the shares are purchased for market value on the “share scheme taxing date”, or 2- they are acquired for market value, are subject to economic risk and the cost is not funded by the employer. If a share received under an ESS is captured, taxable income is triggered based on the difference between the market value of the share on the share scheme taxing date and the amount paid. Similarly, some employers may not be aware that they are deemed to have a tax deduction equal to the amount of taxable income to the employee. This ties back to the rationale that ESS benefits should be treated similarly to generic cash bonuses, for which the employer would also get a tax deduction. Determining the “share scheme taxing date” can be complex, and requires a review of the terms of the ESS. The use of a ‘standard’ template can have unintended consequences when taxable income arises to the employee, along with uncertainty around who should pay the tax on the income - the employee or the employer? By default, it is the employee that is liable, therefore the time at which the employee can sell or redeem their shares becomes crucial if they need to fund the tax liability. Depending on the commercial situation, there might be a real benefit in implementing an ESS. However, that benefit can come at the cost of simplicity. A review of all options should be considered. For example, an employer could consider a bonus arrangement that is like equity, such as ‘phantom equity’. Phantom equity refers to a cash bonus that is calculated based on the change in value of the employer, or a similar equity type measure.