Why improving share-based remuneration for employees is a good move

The Department of Finance’s public consultation on Ireland’s Taxation of Share Based Remuneration closed on 22 January 2024. It’s understood that the responses to the public consultation will feed into the overall review of the taxation of share-based remuneration and the Irish share scheme environment which will be undertaken over the coming months. My tax partner Colin Forbes, head of Global Employer Services, and I were chatting about our submission this week.

The consultation had twenty-plus questions around this area given the various approved and unapproved schemes that are available. Bottom line, share based remuneration is a good thing such that we should add, and not take away, any benefits from their application, so it’s good to talk. Studies have demonstrated that equity participation can be linked to increased company performance which can ultimately lead to greater economic growth.

You might recall that last year’s Tax Strategy Group’s (TSG) Budget 2024 papers noted that “A related additional recommendation of the [Commission of Taxation and Welfare] in relation to share schemes in general that the Department is also considering is to limit the blanket exemption from employer PRSI on share-based remuneration. A review of this matter will form part of a wider consultation on all share-based remuneration which is proposed to be commenced this year”.

So, we’ve now had the consultation and in our view the exemption from employer’s PRSI is effective as it encourages employers to offer shares to employees. The administrative costs of operating share schemes are generally funded by this saving. This is particularly beneficial to start-up companies / SMEs who don’t have cash resources. They need to be able to offer incentives to attract and retain staff where they can’t afford to fund higher cash remuneration. It allows David-type startups to compete with their Goliath-type competitors. In other words, this is an area that we should move on from.

SMEs in particular are having to offer share-based remuneration schemes as a way of competing with the higher salaries that can be afforded by larger competitors. Similarly, prospective senior hires are requesting equity as part of their remuneration package and we expect this trend to continue as the Irish share-based remuneration landscape matures and individuals become aware of the potential value that can be delivered through share-based compensation.

Large private companies are also considering whether they can use share-based remuneration as an effective way of attracting and retaining key talent. They recognise that there are intangible benefits of offering shares rather than cash (e.g., employees acting as shareholders) and they are considering schemes that mirror the types of share incentives used by their listed competitors.

I’ve written about the Key Employee Engagement Programme (KEEP) a number of times in this column and of course it raised its head, rightly, as part of the consultation. The nutshell version is that it’s an exemption from income taxes on any gain realised on the exercise of a qualifying share option under KEEP. Instead, the gain will be subject to Capital Gains Tax (CGT) on a subsequent disposal of the shares. However, take-up on this has been low in the past so we made a couple of suggestions.

Provisions were brought about a couple of years ago to allow companies to buy back its shares acquired by an employee under KEEP. That’s a good thing but still the “KEEP employee” will have to exercise their option and pay for the shares and then hold those shares for five years before they can be redeemed by the company. Therefore, if the 5-year period is to remain then we suggest that 5-year clock starts ticking on the grant of the option.

In addition to the above, valuation is a key part of the KEEP regime in that the share options are granted at market value and also that each employee’s entitlement does not exceed the relevant annual/lifetime limit and that the aggregate issued but unexercised share options do not exceed the company limit. Some suggestions here include the provision of safe harbour for valuations and guidance on how long a valuation remains “in date” (e.g. from last funding round). Further an important issue surrounds where an employer inadvertently gets the valuation wrong. Right now, this would mean the options would cease to qualify for KEEP which seems disproportionate to something that is a subjective exercise anyway. Opinions will always differ in connection with valuation. Therefore, we suggested that on exercise employees would be subject to income taxes only on the difference between the exercise price and the actual market value of the shares on grant. The balance of the option gain should continue to be subject to CGT.

Many companies would typically grant options with a 10-year life span and in fact this is the permitted life span of a KEEP option. However, and separately to KEEP, tax law applying to unapproved options specifies that where a share option is capable of being exercised more than 7 years after it is granted (i.e., a long option) then a charge to income tax may arise on both the grant of the share option (if granted at undervalue) and the exercise.

On that basis we suggested removing the possibility of options being taxed at grant which would ease the application and administration of share options. Also, this change would bring Ireland into line with other territories which do not seek to tax the grant of an employee share option.

Currently multi-national companies seeking to extend their option plans to Ireland incur additional cost in adding specific rules to address the 7-year limit in Ireland. We believe this proposed change should be cost neutral on the basis that currently employers typically restrict options to a 7-year time limit and on expiry might seek to provide alternative incentives.

Regular readers of this column will know my mantra that when it comes to investment, simplicity will eat complexity for breakfast. Overall, share based remuneration is a good thing and we can make it simpler and better for all.

Please note this article first featured in the Business Post on Sunday, 4 February 2024 and was re-published kindly with their permission on our website.