Share-based remuneration

Relevant to Paper P6 (IRL)

Share-based remuneration schemes are used by employers to reward their employees and ensure their continued commitment. They are mainly used by public companies because it is often difficult to provide a market for the shares of private companies.

Significant changes were made to the tax and social security treatment of share-based remuneration arrangements in the 2011 budget. The introduction of pay-related social insurance (PRSI) and universal social charge (USC) to these arrangements has made them more expensive for employees from a tax perspective and the administrative burden on employers has been increased. (The charge to PRSI will not apply where the share-based remuneration is the subject of a written agreement entered into between the employer and employee before 1 January 2011). It is also important to note that the concept of ‘approved’ share option schemes was abolished with effect from 24 November 2010, so all share option schemes are now effectively ‘unapproved’.

This article explains the tax treatment of four different types of share-based remuneration and is relevant to candidates preparing to sit the Paper P6 (IRL) exam. Illustrative examples are provided based on the legislation applicable to the June 2014 and December 2014 exam sittings (Finance Act 2013). These illustrative examples are prepared on the assumptions that the employee pays tax at the higher rate and has already used their annual exemption for capital gains tax (CGT).


1. Share Awards

A. Basic Share Awards
An employer can simply award shares to an employee, either free of charge or at a discounted price.

Implications for the employee
The value of the shares awarded in the case of free shares (or in the case of discounted shares, the market value of the shares less any consideration paid by the employee) is treated as notional pay at the time that the shares are awarded. This notional pay is subject to:

  • Income tax at the employee’s marginal rate
  • USC, and
  • Employee PRSI.


The effective tax burden for a higher rate taxpayer will be 52% (41% + 7% + 4%).

CGT will arise on a subsequent sale of the shares by the employee if the shares are sold at a price higher than their value on the day that they were awarded to the employee (the CGT base cost).

Implications for the employer
Revenue approval is not required for share awards and the shares do not need to be offered to all employees.

With effect from 1 January 2011, the employer must account for the above taxes (excluding CGT) through the PAYE system in the same way as it does for other benefits in kind (BIK). This can have cash flow implications for the employer. The employer can collect the taxes due from the employee in future payroll periods provided the liability is paid in full by 31 March of the following tax year. Otherwise another BIK charge will arise on the outstanding balance. Finance Act 2012 provisions allow an employer to withhold or sell sufficient shares to fund the taxes due on the award of the shares, before transferring the balance of the shares to the employee.

Share awards are not subject to employer’s PRSI.

The taxes should be remitted in the month following the share award.

Example 1
Mark received 1,000 free shares valued at €5 per share from his employer on 1 January 2013. He sold all of the shares on 6 June 2013 at a price of €8 per share.

First, the award of shares by Mark’s employer is valued at €5,000 and will be subject to payroll taxes amounting to 52%.

Second, the chargeable gain of €3,000 (€8,000 – €5,000) will be taxable at 33%.

B. Restricted Share Awards (Share ‘clog’ abatements)
The Revenue will allow a reduction in the taxable value of the free or discounted shares, if the shares are subject to a restriction on disposal for a fixed period (the ‘clog’ period). Such shares are referred to as restricted shares. During the ‘clog’ period the shares must not the sold, assigned, charged, transferred or pledged as security for loans and a written contract must be entered into to this effect. This point is important when advising clients who are seeking loans and may wish to offer their shares as security.

The employer will place the shares in a trust for the benefit of the relevant employees. The longer the ‘clog’ period, the greater the reduction in taxable value.

The following table summarises the position.

Period of restriction% reduction
One year
10
Two years20
Three years30
Four years40
Five years
50
Over five years
60

Implications for the employee
The tax implications for the employee are the same as for basic share awards. However the taxable value can be significantly reduced depending on the ‘clog’ period.

Again there may be a CGT liability on any additional gain made on the disposal of the shares. The base cost of the restricted shares is the gain for income tax purposes (ie the abated amount).

Implications for the employer
The tax implications for the employer are the same as for basic share awards.

However, the employer must report to the Revenue (on a standard form RSS1) before 31 March in the following tax year in circumstances where:

  • restricted shares have been awarded to employees, or
  • restricted shares have been forfeited, or
  • shares have been disposed of prior to the end of the ‘clog’ period.


There are penalties for failure to make this return or for making a false return.

Example 2
In Example 1 above, if the shares were issued to Mark subject to a condition that they should not be disposed of within three years, the taxable value of the share award would be reduced by 30% to €3,500. Payroll taxes amounting to 52% would apply to this amount.

Mark’s base cost for CGT in the event of a disposal (after the expiry of the three year period) would be €3,500.


2. (Unapproved) Share Option Schemes

A share option is an option to purchase shares in the employer company at a future date at a fixed price (the option price). The purpose of a share option is to provide eligible employees with the opportunity to participate in the profitability and growth of the company.

It is important to note that the concept of ‘approved’ share option schemes was abolished with effect from 24 November 2010, so all share option schemes are effectively ‘unapproved’. However, even when the tax legislation provided for ‘approved’ share option schemes, unapproved schemes were still a popular choice among employers because of the flexibility which they offered.

Implications for the employee

  • There is no upfront charge to tax on the grant of the share option unless the option is capable of being exercised later than seven years after it is granted (a ‘long option’ – see note below).
  • On the date of exercise of the share option, income tax, employee PRSI and USC (max 7%) arises on the difference between the option price and the market price at the date of exercise.


The taxes are payable by the employee under a special self- assessment system, Relevant Tax on Share Options (RTSO), within 30 days. The PAYE system does not apply to the above taxes on income chargeable in respect of the share options. However, the option holder must also file an Income Tax Return by 31 October following the year in which the gains on exercise are realised.

CGT applies to the difference between the sales proceeds and the base cost (exercise value).

Note: If the option is exercisable after seven years (a ‘long option’), then income tax at the marginal rate, PRSI and USC will apply to the difference between the option price and the market price at the date of grant. Tax practitioners therefore recommend that the option price for the shares should match the market value of the shares at the date of grant if the option exercise period exceeds seven years. Subsequently tax is also charged when the option is exercised, but credit is available for any tax paid at the time the option was granted.

Implications for the employer

  • The responsibility for paying all taxes rests with the employee and not the employer (with effect from 1 July 2012).
  • Employer’s PRSI does not apply.
  • The employer must report to the Revenue (on standard form RSS1) before 31 March in the following tax year. The information that must be provided includes details of the granting of share options, the allotment of share options and the release or assignment of share options.


Example 3
Mary was granted options over 5,000 shares on 1 January 2013 by her employer Bigco plc. The options were capable of being exercised within four years. The options were granted at 70c each which was the market value on the date of grant. Mary exercised her options on 1 September 2013 at which date the market value was €2 per share. Mary sold the shares on 2 September 2013 for €2.50 per share.

No charge to tax arises on 1 January 2013 because the option period is only four years.

On the date of exercise of the share options (1 September 2013) taxes are calculated as follows:

  
Option price (5,000 x 0.70)3,500 
Market value at exercise
(5,000 x €2)
10,000(Base cost for CGT)
Gain on exercise6,500 
Tax at 52%3,380 

The CGT is on disposal is calculated as follows:

  
Sales proceeds (5,000 x €2.50)12,500 
Less: Base cost (10,000) 
Chargeable gain 2,500 
CGT at 33%825 


3. (Revenue) Approved Profit Sharing Schemes (APSS)

An APSS is a revenue approved scheme where employees and directors can convert a profit sharing bonus into shares in their employer company. An employee may also voluntarily apply a percentage of his/her basic gross salary towards the purchase of shares. This is called ‘salary foregone’ and the amount cannot exceed 7.5% of the salary or 100% of the employer-funded bonus, whichever is lower. The shares are held in trust for a minimum of two years, but they need to be held in trust for three years to enable the employee to avoid a liability to income tax.

Implications for the employee

  • There is no income tax charged on the appropriation of shares – ie when the shares are originally granted). However (with effect from 1 January 2011), the income tax free share appropriation amount is charged to USC and employee PRSI (a combined 11% in most cases) at the time of appropriation.
  • If the employee shares are retained in the trust for three years there is no liability to income tax, USC or PRSI on the transfer of the shares to the employee at the end of the three year period.
  • If the employee receives the shares from the trust within the three-year holding period he/she is deemed to have earned Schedule E income in the year in which they receive the shares, on the lower of the following two amounts:
    - Amount of sales proceeds, or
    - The market value of the shares when the shares were acquired by the employee.
  • If the shares are subsequently sold or gifted there will be a CGT exposure.


Implications for the employer

  • The scheme is not subject to employer’s PRSI.
  • Arrangements must be made to collect employee PRSI and USC through the payroll system.
  • The scheme must be established under a trust deed and must be approved by the Revenue. It must be open on similar terms to all employees who have been employed for a minimum period set by the employer, not exceeding three years.
  • The maximum exempt allocation per employee is €12,700 worth of shares in any tax year.
  • An employee may not participate in the scheme if he/she owns more than 15% of the share capital of a company and it is a ‘close’ company.


Example 4
Shares with a value of €6,000 were appropriated to Kevin by his employer XYZ Global plc under the terms of its APSS on 1 January 2012.

Kevin received the shares from the trust on the expiry of the required three year period (on 1 January 2015) and immediately sold the shares for €10,000.

The tax implications are as follows:

  • On 1 January 2012 Kevin has no income tax liability, but will be liable for PRSI and USC of €660 (a combined rate of 11% on the share value of €6,000). This will be collected through the payroll system of XYZ Global plc.
  • On 1 January 2015 when Kevin receives the shares from the trust, no further charge to income tax, PRSI or USC will arise as the shares have been held in trust for three years.
  • Kevin will be liable to CGT in 2015 of €1,320 (being 33% of the difference between the sales proceeds of €10,000 and his base cost in the shares of €6,000).


Example 5
Assume the same details as Example 4, except that Kevin receives the shares from the trust after two years (on 1 January 2014).

  • On 1 January 2012 , Kevin has the same liability for PRSI and USC (€660), as in example 4.
  • On 1 January 2014, Kevin becomes liable to income tax at 41% on the lower of the sales proceeds and the market value of the shares when acquired (ie €6,000), which gives a liability of €2,460.
  • Kevin’s CGT liability is the same as in Example 4 ( €1,320)

 

4. (Revenue Approved) Save As You Earn (SAYE) schemes

Revenue approved SAYE schemes involve two stages:

Stage 1
On joining the scheme an employee agrees to save a fixed monthly sum (subject to a maximum of €500 per month) out of their net pay for a pre-determined savings period of three, five or seven years. The return on savings is tax-free (ie exempt from income tax, deposit interest retention tax (DIRT), PRSI and USC). The employee is granted share options on the basis of the amount they agree to save. Options may be granted at a discount of up to 25% of the market value of the shares at the date the option is granted.

Stage 2
At the end of the savings period the employee can:

  • use the proceeds to buy some or all of the shares covered by the option
  • take the proceeds as a tax-free cash lump sum, or
  • continue to invest the proceeds with a financial institution


Implications for the employee

  • There is no income tax charged on the grant of the options under the SAYE scheme (stage 1) or on the exercise of the option (stage 2).
  • However (in relation to options granted and exercised after 1 January 2011), there will be a charge to both USC and employee PRSI (a combined 11% in most cases) when the option is exercised (stage 2). The chargeable amount will be the amount of the option gain at the date of exercise.
  • CGT may arise on the disposal of the shares on the difference between the disposal proceeds and the option price at acquisition (ie the amount paid by the employee to acquire the shares).


Implications for the employer

  • The scheme is not subject to employer’s PRSI.
  • Arrangements must be made to collect employee PRSI and USC through the payroll system.
  • The scheme must be open on similar terms to all employees who have been employed for a minimum period set by the employer, not exceeding three years.
  • Employers must complete an annual return of information (Form SRSO1) regarding the options. The deadline for filing of this form is 31 March each year.


Example 6

Stage 1
On 1 February 2011, Linda agreed to save €50 per month for five years under her employer’s SAYE scheme. On that day, the company share price was €4 and Linda was granted options to buy up to 1,200 shares at €3 per share (a 25% discount).

Stage 2
At the expiry of the five-year savings period (1 February 2016), Linda’s savings amounted to €3,300 including interest. Linda was in a position to buy 1,100 shares at the option price of €3 each. The market price on 1 February 2016 was €8 per share. Linda then sold the entire holding at €8 each (which was the market value on that day) and thus realised sale proceeds of €8,800.

  • On the exercise of the option after five years, there is a gain of €5,500 (being €8,800 less €3,300). This is subject to PRSI and USC of €605 (11%). No income tax arises on this gain.


CGT at 33% applies to the gain on disposal (which is also €5,500). The resulting CGT liability is €1,815.


Conclusion

It can be seen from the above that, notwithstanding recent legislative changes, the Irish tax system still provides for a number of different schemes to facilitate employers in allocating shares or granting share options to their employees in a tax-efficient manner. All four schemes remain exempt from employer’s PRSI, which is an advantage over other types of employee benefit. The important income tax exemption can be achieved through use of the APSS and SAYE schemes, but the employer must be prepared to offer the scheme to all employees and the employees must be prepared to wait a few years, before realising the benefits. In similar fashion, in relation to share awards, a significant reduction in the taxable value of the benefit may be achieved if a time restriction or ‘clog’ is placed on the disposal of the shares. To summarise, ‘Good things come to those prepared to wait.’

Written by a member of the Paper P6 examining team