The pros and cons of the Key Employee Engagement Programme (KEEP) and the Restricted Share Scheme.
Attracting and retaining staff is one of the key issues for employers. How to reward staff in a manner that encourages both performance and loyalty is a constant challenge. Share-based remuneration has long been a feature of incentive plans for employees. It can take many forms, such as tying bonuses to share price performance or in some cases awarding shares in the company to employees.
The tax treatment, while not the only consideration, can make or break such incentive plans. Fortunately, tax legislation contains some reliefs for various employee share schemes and we will now consider two such schemes that may be of particular relevance to SMEs.
Key Employee Engagement Programme (KEEP)
Finance Act 2017 saw the welcome introduction of the new share options scheme, KEEP. This scheme is likely to be of benefit to employers who wish to award employees the opportunity to earn a bonus based on future share price performance without them necessarily becoming long-term shareholders in the company.
How the scheme works
KEEP applies to qualifying share options granted between 1 January 2018 and 31 December 2023.
In summary the scheme works as follows:
- An employee is granted an option to acquire shares at a price that is no lower than today’s market value – therefore the employee is not awarded any existing value in the company
- If, by the time the employee exercises the option the shares have increased in value they are not subject to tax on the uplift at that time
- Instead, they will be subject to Capital Gains Tax on the uplift if and when they dispose of the shares and realise this uplift
- The employer will not be liable to Employers’ PRSI
The scheme entitles employers to award a bonus, contingent on share price appreciation, that is not subject to income tax, PRSI or USC. Instead it is subject to CGT rates, although it is a little disappointing that, unlike the UK’s Enterprise Management Incentive (EMI) scheme, there is no easing of the conditions for the 10% CGT rate under Entrepreneur Relief to apply to shares issued under the KEEP Scheme.
Advantages of the scheme
- Incentivisation: Employees are incentivised to maximise performance, knowing that they will share in any share price appreciation
- Flexibility for employer: A key feature of the scheme is that the employer can be selective in offering it to employees, i.e. there is no requirement to offer it to all employees
- Flexibility for employee: The employee will have a considerable period of time (up to ten years) during which to exercise the option. Once exercised they do not have to retain the shares for a minimum period, i.e. they may choose to dispose of the shares immediately after exercising the option. This can give great flexibility for an employee to exercise the option at an opportune time and realise value in a timely manner
- Facilitates broader employee participation: As an options-based scheme, employees tend in practice to exercise the options and quickly (perhaps even immediately) sell the shares to realise their value. By employees not opting to become long-term shareholders, employers are encouraged to extend the benefits of share-based remuneration to a wider group of employees without greatly expanding the shareholder base
- Cost and administration: While there are some administrative obligations, KEEP is still likely to carry a much lower cost and administrative burden than some existing share-based remuneration schemes, in particular the Approved Profit-Sharing Scheme, and therefore be more attractive to SMEs.
Some disadvantages of the scheme:
- Lack of rigidity: As noted above, while the likelihood that most employees will not end up becoming long-term shareholders in the company can have its advantages, it may not appeal to employers who are keen to lock in key employees as shareholders for a period of time. Such employers may find the Restricted Share Scheme (outlined below) more appealing
- Time value of money: An employee may prefer to take a cash bonus up-front, even if subject to Income Tax, rather than a bonus that is both uncertain and might not be realisable for a number of years. Easier availability of Entrepreneur Relief would have enhanced the attractiveness of KEEP in this regard
- Realising value: There is no certainty that the employee will be in a position to realise value from any shares after exercising an option. A sale of the company can create a great opportunity to cash in the value of the options but such an opportunity may take a long time to materialise, if it ever does. Alternative options may be considered but will require careful planning and structuring – will the company create a market in the shares or will a redemption of the shares be possible, for instance?
Restricted Share Scheme
In some cases, an employer may wish to award shares directly to some key employees. In addition to giving them a greater sense of responsibility and incentivising them to drive company performance, it may also serve to instil loyalty to the company. Unlike the KEEP Scheme, this allows the employer to give the employee some of the existing value in the company.
Where an employee is given shares in their employer company, they are subjected to Income Tax, PRSI and USC on the market value of those shares. Furthermore, the tax is payable at that time even though they most likely won’t have realised any value from the shares.
The tax legislation however provides for a reduction in this tax liability where a time restriction is placed on the employee’s entitlement to dispose of the shares. The reduction in the taxable value of the shares can be as high as 60%, as illustrated in the table below.
|RESTRICTED PERIOD||REDUCTION IN TAXABLE VALUE|
|More than five years||60%|
The downside is that the tax liability, although greatly reduced, will still be payable up-front even though the employee will not be in a position to realise any value in the shares for a number of years. It may however be possible for the employer to give a loan to the employee to pay this tax liability, although this carries tax and commercial implications of its own and would have to be carefully structured.
Benefits of the Scheme:
- Building senior team: This scheme may be useful where there is one, or a number of key employees to whom the employer wishes to give a stake in the company
- More tangible value for employee: The employee in this case is getting shares that have an existing value. This is in contrast with the KEEP scheme where they get no benefit from the options unless the share price appreciates
- Loyalty: Employee is locked in as a shareholder for a number of years, which can have the effect of engendering greater loyalty on their part
- Incentivisation: As shareholders, the employees will be incentivised to drive share price performance
Some disadvantages of the scheme:
- Administration burden: It will entail setting up a Trust to hold the shares for the restricted period, which can add a layer of complexity, although this can be managed
- Realising value: As with the KEEP scheme, a key challenge will be how to enable the employee to convert the shares to cash
- Time value of money: As with the KEEP scheme, the employee may prefer an up-front cash bonus, especially when the restricted period is factored in
Which scheme is best for you?
Each business will need to weigh up the benefits and downsides of each scheme and ascertain if they meet their objectives at that particular time. As noted above, KEEP is more likely to be suitable where the intention is to offer staff the opportunity to earn a bonus based on share price performance while the Restricted Share Scheme may be more suitable where the intention is to introduce a small number of key employees as long-term shareholders.
KEEP SCHEME –KEY CONDITIONS
The company in which the options are granted must be:
- A micro, small or medium sized enterprise; this is a company with fewer than 250 employees and either turnover of less than €50m or a Balance Sheet total of less than €43m
- Irish resident or else resident in an EEA member state but carrying on a trade in Ireland through a branch or agency
- Carrying on a qualifying trade; most trades qualify other than a number of specific exceptions such as construction and related services, forestry, shipbuilding, professional services and dealing in shares and financial assets.
- Holding companies can also qualify but only where the sole activity is the direct holding of 100% of the shares of qualifying companies; this is quite restrictive and in practice it may be necessary to issue the shares in the trading company itself.
The scheme can be offered to any qualifying employee; however, the employer can be selective as there is no obligation to make it available to all such employees. A qualifying employee is one who:
- Is a full-time employee or director of the company who is required to work more than 30 hours per week in a position that is capable of lasting more than 12 months
- Does not own (either alone or with connected parties) more than 15% of the ordinary share capital of the company
The shares must be unquoted, ordinary shares that are fully risk-bearing and carry no preferential rights to dividend or value.
The option must:
- Not have a life of more than 10 years
- Not be exercisable in the first 12 months after grant
- Not exceed either 50% of the employee’s salary or €100,000 per annum; the total options granted to an individual employee over a three-year period must not exceed €250,000
The maximum value of unexercised share options issued by the company cannot exceed €3m at any one time.
If you would like assistance in developing an employee incentive scheme for your business, please contact a member of our tax team.