Owner Management - RSM Ireland Tax Partner, Suzanne O'Neill, discusses how share equity can play a crucial role in augmenting loyalty and hanging on to talent.
As business owners assess their exit strategies, an experienced and motivated management team is a very valuable and vital resource in growing the business. “With the growth in the economy generally and the increased availability of employment opportunities, private companies are seeking innovative ways of retaining key individuals within their business,” said Suzanne O’Neill, Tax Partner, RSM Ireland.
Share equity can play an important role in establishing loyalty and retaining talent. Providing management with stake in the business has been proven to create growth in companies and assist in staff retention.
“Employees are motivated and bought in to the company’s growth strategy as it increases the value of their own investment in the business,” said O’Neill. “A scheme that enables companies to incentivise a small number of key employees with equity is what is sought. Share incentive schemes are a valuable alternative to cash bonuses, from a cashflow perspective for the owner, and from a tax efficient perspective for both the employer and employee.”
The tax treatment of traditional share schemes in Ireland have favoured multi-national organisations. “The schemes put in place by multi-nationals enable employees to quickly convert their shares into cash by selling them,” said O’Neill. This is not possible for shares held in private Irish companies as it is not easy to convert them into cash. In traditional share schemes employees pay income tax on the difference between the market value of shares at the date of exercising share options and the price paid by the employee for the shares. “Realistically this tax can only be funded through the sale of the shares and as a result such schemes are only suitable for employees who have a ready market for those shares,” O'Neill said.
This imbalance has been addressed by the introduction in of the KEEP scheme (Key Employee Engagement Programme) from 2018 and further changes are been introduced in the current Finance Act to address shortcomings identified. “Under the KEEP scheme there is no tax payable by the employee on the grant or exercise of the share options, so no upfront tax cost arises,” said O’Neill. “The employee is only subject to capital gains tax on the ultimate sale of the shares, which allows the employee to fund the tax charge from the sale proceeds. The KEEP scheme enables the business owners of private companies to provide share equity to on a selective basis.”
For the share scheme to be of benefit to employees in private company, it is necessary that there be a sell strategy in the future to enable employees and owners to convert their shares to cash.
The employee must purchase the shares which involves a cash outlay. “The price at which the shares options are granted cannot be less than the market value of the shares when granted,” said O’Neill. “The scheme is most suited therefore to entities where future growth is anticipated which the employee can benefit from. The tax treatment for the employee is equivalent to any other share investment with CGT payable on the uplift in value of the original price paid for the shares over the sale proceeds.”
The normal rate of capital gains tax is currently 33%. “Employee may alternatively qualify for a reduced rate of CGT of 10% through entrepreneur relief where they meet the relevant conditions,” said O’Neill. “The conditions or entrepreneur relief are most likely to be met in a small company as the employee must hold at least 5% of the shares in the company for at least three continuous years and be involved in the management of the company in a technical or managerial capacity.”
For private companies where the shares are held in family ownership the decision to widen the ownership to include employees requires careful consideration said O’Neill. It will require changes to the existing shareholder’s agreement to address all possible circumstances and avoid conflict or dispute within the company.
“The treatment of the shares in the event of the employee leaving the company will need to be considered with clauses included as how those shares are treated,” said O’Neill. “For private companies in growth mode with the goal of building for sale, share equity for key management is worthy of consideration, where the management have the appetite to share in the risks/rewards of the business with the owners to their mutual benefit.”
“At RSM Ireland, we are working with an increasing number of companies who are looking to utilise share incentive options, across domestic and international companies. We assist companies with both taxation and non-taxation consideration including company valuations and accounting requirement”.
As seen in the Business Post, 8th December 2019.