Corporate employers impacted by the Covid-19 pandemic are understandably looking to conserve cash in their businesses and simultaneously incentivise their employees who have adjusted to new working patterns.
Many companies would have benefited from the UK’s Coronavirus Job Retention Scheme (CJRS), which was temporarily implemented to alleviate the financial impact of the pandemic on businesses. The CJRS was designed to help employers retain staff during the pandemic, even if they are forced to shut their business temporarily. The CJRS has been extended until the end of October 2020. However, as the scheme gradually comes to an end, companies will need to be innovative in the way they manage cash and motivate their workforce. This will limit the longer-term economic impact of the pandemic on their business.
It is widely accepted that enabling employees to share in the growth in value to which they contribute by their labours is, in any event, a “good thing”. What is not so widely appreciated is that for 20 years now the UK government has afforded very generous tax benefits to those independent corporate employers who invite all their employees, having a qualifying period of employment and on a ‘same terms’ basis, to acquire and hold shares in the company or its holding company by participating in a SIP. Some 840 UK companies, including many of the major retailers and manufacturing companies, as well as an increasing number of small and medium-sized enterprises, have taken advantage of the benefits and savings afforded by establishing and operating a SIP.
A company can reduce the cash costs on the business by paying some of their employees’ salaries in shares. This article considers how a UK independent company might do so, in a highly tax-efficient manner by awarding shares under a SIP (in the hope they will grow in value and be capable of being sold) instead of cash remuneration. “Jam tomorrow” perhaps, but if the choice is “little or no jam – or even bread - today”, the idea of participating in future growth as a shareholder, and with favourable tax treatment, may be of real attraction to employees who are otherwise at risk of redundancy.
Unlike tax-advantaged share options, a SIP may be established by any independent employer company, whatever the nature of its business – whether investment or trading. Within limits, the SIP may provide for employees to acquire shares by way of gift and/or purchase out of pre-tax salary or bonus. Shares so acquired and held by the SIP Trustee may ultimately be sold entirely free of tax. SIPs now use standard documentation and can be operated with relative ease of administration. They do however require the establishment of a trust with UK trustees (“the SIP Trustee”), such as Fiduchi Trustee (UK) Limited.
Under a SIP, if shares are to be offered on any given occasion (which could be a one-off, annual, ad hoc, or on a continuing monthly basis) they must be offered to all qualifying employees, either as “free” shares (up to a limit of £3,600 per tax year) and/or as shares (referred to as “partnership shares”) purchased out of an amount deducted from the employee’s gross salary or bonus (up to a limit of £1,800 or, if less, 10% of salary, per tax year). If purchased out of pre-tax salary or bonus, the shares will be acquired at an effective discount to their market value. In the case of an unquoted company, that market value will, for the purpose of applying those limits, be discounted to reflect the lack of marketability and size of the holding.
An award of free shares to all qualifying employees may be subject to the attainment of objective performance conditions. Those employees who purchase partnership shares may be offered additional “matching shares” on the basis of up to ‘2 matching shares for every one partnership share’.
Crucially, for a private company, the shares used may be of a distinct class of restricted and non-voting ‘employees’ shares’, although their (discounted) market value must still be determined, for the purpose of applying the limits on the acquisition, without regard to the further depreciatory effect of any such restrictions. Restrictions typically ensure that a participant who leaves at any time, or within a given period, may be required to ‘forfeit’ his or her ‘free shares’, and to offer to sell back ‘partnership shares’ on a ‘no-gain’ basis. Such safeguards ensure that there need be no economic cost to other shareholders unless and until the company is sold (when the proceeds of the sale are shared with all employee participants).
The generous tax treatment means that, in a simple case, the cash cost to a company of paying salary or bonus of, say, £1,000 (which, with the 13.8% employers’ NICs, and relief from corporation tax at, say, 19% represents a cash cost to the employer of £922) results in a net of tax benefit to the employee (assuming a 42% marginal tax rate, including the employee’s NICs) of only £580. In contrast, an award of £1,000 of free shares newly-issued to a SIP trust (which subscribes using a cash contribution from the company – the money being immediately returned to the company) can allow an employee to acquire shares with an initial value of £1,000 and a net cash benefit to the company of the £190 corporation tax relief on the cash contribution made to the trust!
Given that, in the case of an unquoted company, the value of a small holding acquired under a SIP will be at a discount to the pro-rata value of the shares, if the shares are eventually disposed of when the company is sold, this can result in a dramatic leveraging effect upon the value ultimately realised by a participant. For example, if a discount of, say, 50% is appropriate when determining the unrestricted market value of a share, then £1,000 will purchase partnership shares having a pro-rata value of £2,000. As these are purchased out of pre-tax salary, the effective cost to the employee is (assuming a 42% marginal tax rate) £580. If the company is sold when the company has doubled in value, the participant would receive £4,000 free of tax, representing an investment return of roughly 590%!
Plan shares are required to be held on behalf of participants by the plan trustee and may be allowed to remain with the trustee for so long as the participant remains with the company or group. Plan shares will be automatically withdrawn from the plan (and the ‘tax shelter’) if the employee leaves. If that is because of injury, disability, redundancy, retirement, death or TUPE transfer (“a good leaver”) the shares, if not then forfeited, may be sold in accordance with the articles of the company with no immediate tax consequence. Otherwise, a charge to income tax may arise if the employee leaves within five years from the date of award or acquisition, unless the shares if they are “free” or “matching shares” are then forfeited. Partnership shares may be withdrawn at any time, but free and matching shares may be withdrawn only after a holding period which must be set at a minimum of 3-years. If plan shares are withdrawn within five years, then – unless this is because they are sold for cash when the company is sold, or the employee is a good leaver – a ‘clawback’ charge to income tax may then arise (the amount depending upon whether they have been held in the plan for more or less than three years). In practice, if there is no market in the shares, there is no reason for an employee to withdraw plan shares unless and until they may be sold for cash.
There is no charge to tax if plan shares are (and may only be) sold for cash because the company is sold at any time.
Whilst the rules of a SIP and the tax provisions may at first seem relatively complex; experience shows that, for companies with even relatively small numbers of employees, the benefits of a SIP can be both generous and well regarded by participants. Shareholders of a private or unquoted company not aiming to sell it within the foreseeable future would need to consider whether, and if so how, to enable participants who are ‘good leavers’ to sell their shares. However, it may be possible for such shares then to be ‘recycled’ by once again being awarded to subsisting employees.
A SIP affords a great deal of operational flexibility. So, for example, qualifying employees could be invited to authorise deductions (of up to £150) from monthly payments of gross salary over a period of up to a year, the amounts so deducted being retained by the company or the trustee and applied in the acquisition of “partnership shares” at the end of that “accumulation period” at a value fixed as the market value at the start of that period – in effect, granting the employees a one-year ‘savings-related’ share option. That said, employees cannot be offered a straight choice of ‘cash or shares under a SIP’; but awards instead of discretionary pay, or as a substitute for a pay increase, are permitted.
An invitation to acquire shares could, in the case of an ‘early-stage’ growth company, be made to those who are the founding employees before the company increases the size of its workforce. Likewise, there may be real commercial benefit to issuing an invitation to acquire shares (as “free” and/or “partnership” and/or “matching” shares) under a SIP to those employees who remain after the company has had to make reductions in its workforce to reflect the new economic environment. Assuming the company ‘bounces back’, the acquisition of shares under a SIP may prove to be a valuable ‘thank you’ to those employees who may have suffered reductions in pay and other benefits in support of the company’s survival.
The above article is produced in partnership with one of the UK’s leading share plans lawyer and tax barrister, David Pett of Temple Tax Chambers.
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Global crises, like that presented by COVID-19, cause economic shockwaves around the world. They pose serious challenges to businesses across all sectors and geographies, including how to keep employees engaged in challenging times? And, how to ensure that they are incentivised to outperform in the future?
Fiduchi is a provider of trust and company services, and therefore its experts are well placed to help clients implement SIPs. We liaise closely with other advisers to ensure that all relevant legal, tax, accounting and valuation aspects are seamlessly covered in designing and implementing your SIP.