No matter what size of the company you run, there is always scope for an employee incentive plan to motivate and retain your staff, says Olive O'Donoghue, Tax Partner in KPMG. 

What better way to incentivise your employees to stay with your business and perform at their best than to make it worth their while financially? 

Owners and managers of privately owned companies often think employee incentive plans are more suitable for large public companies and multinationals, but in fact, they're proven to be highly effective for companies of all types. They not only incentivise individual performance but foster collaboration and innovation as employees work together towards the collective goal of growing the value of the business.

What are incentive plans?

Employee incentive plans (also often referred to as employee retention or reward plans) typically involve offering a cash or equity-settled award to staff to motivate and encourage them to remain with and help grow your business. They're typically subject to time-based and/or performance-based conditions. 

When aimed at bolstering retention rates, ultimate payout or "vesting" will generally depend on the employee remaining in employment at a particular point in time. For example, a plan with a three-year vesting period might require an individual to remain in employment with the company at the end of those three years to get a payout under the plan.  

In terms of performance-based conditions, these can require the individual and/or the company to meet or exceed certain performance targets before which a payout occurs. 

As in so many strands of business currently, environmental, social and governance (ESG) targets are increasingly becoming a feature of incentive plans. Rather than measuring success purely on business and financial performance, companies are starting to include a measure of company or individual contribution to ESG objectives. 

An employer generally has full discretion over the types of conditions to attach to any incentive plan. 

Cash versus equity – what's best for your business?

Off the back of an increasingly inflationary environment over the last 18 months, more and more businesses are focussing on preserving cash. They are looking to equity-based incentive plans as an attractive and efficient alternative to cash to incentivise their workforce.

Private enterprise incentive plans, more often than not, tend to be cash-based in nature. This can be for a number of reasons which might include a reluctance on the part of current shareholders to give away an equitable share in the business. Also, there can often be a perception that equity-based plans are not workable in a private company, given a potential inability to sell the shares and the difficulties that can arise when valuing the share for tax purposes. While these may be very valid reasons in some cases, there are many private company scenarios where these issues can be more easily managed, and the tax benefits of receiving equity for the employee (and indeed, the employer) can outweigh a cash receipt. 

Under a cash-based plan, the employee is likely to be fully subject to PAYE, USC and employee PRSI via the PAYE system. In contrast, where an employee is awarded shares in the business, while an upfront charge to PAYE, USC and employee PRSI can arise, there is a possibility that the employee could avail of the lower Capital Gains Tax (CGT) rate (currently 33%) on a subsequent sale of the shares in the future. 

It is also worth noting that employers may be eligible for an exemption from employer PRSI on equity-settled plans, resulting in an 11.05% cost saving if they choose that option over offering cash incentives. 

What are popular equity plans?

One of the most tax-efficient share incentive plans for an Irish taxpayer is a Restricted Share Plan (often referred to as a "clog" plan). Under a clog incentive plan, the employee is awarded shares, but the shares are held in a trust for a specified period. Throughout this specified period (which ranges from 1 year to greater than 5 years), the employee can't transfer or sell the shares and cannot pledge them as security or assign them to someone else – they're effectively locked away. 

The benefit of placing such restrictions on shares is that the market value of the shares for tax purposes is reduced for the employee depending on the length of time the shares are subject to these restrictions. For example, if an employee holds shares in a trust for more than five years, a 60% discount on market value would be available for PAYE, USC and PRSI purposes.

Growth share plans are also becoming more and more popular, particularly in private companies where private equity investment has taken place, and there is an expectation for significant growth in the business to take place in the short to medium term.

A growth share plan generally involves the creation of a new share class that entitles the employee to participate in the value of the business over a certain hurdle on the happening of a specific exit event like a sale or IPO. Given the employee will only receive value to the extent the business grows, it ensures that the employee's objectives to maximise the growth of the business are closely aligned with that of the employer. Typically, the value placed on a growth share will be lower than a regular share given the growth shareholder will not participate in the existing value of the group. This can make the upfront charge to PAYE, USC and employee PRSI more manageable for employees. 

Understanding some of the potential hurdles

Before selecting or implementing any form of employee incentive arrangement in a private business a number of issues should be considered. Some of these issues include:

Tackling the liquidity issue

When implementing any equity-based incentive plan in a private business, it's crucial to consider upfront how an employee can ultimately realise the value of their shareholding down the line. There may be an obvious path where a sale or IPO is on the horizon in the short- to medium term. 

However, many private businesses in Ireland are family-owned and often, the families do not have any intention to sell the business. Assuming the family is willing to make someone outside the family a shareholder, the company would need to consider how it might create an internal market for the employee's shares at some point in the future. This can often involve some form of company buyback facility, which tends to create more complex tax issues for consideration. 

One mistake an employee and employer can make is to assume that where shares are awarded that CGT and only CGT will be payable on a subsequent disposal or transfer of the share. Care should be taken in a private group context as often further income tax charges can arise where the employee receives consideration for their shares otherwise than on a straightforward sale to a third-party purchaser. For example, share buybacks or redemptions of shares on cessation of employment could give rise to additional income tax liabilities if not managed carefully.  

"It’s vital to safeguard the business and protect founders and majority shareholders at all times."

Getting the valuation right

If you're giving any employee a share in your business, it's vital to get the valuation right for them and for you. Their personal tax liability is driven off the market value of the shares on the date of award. At the same time, if the shares are undervalued, the company (as the employer) could be exposed to additional payroll taxes, together with interest and penalties, if challenged by Revenue. Valuation can be costly if you get it wrong, so make sure you get advice prior to implementing any share-based plan.

Understanding the accounting impact

Employee incentives arrangements fall within the scope of either IFRS 2 Share-based Payment or IAS 19 Employee Benefits. While share-based payments are common long-term employee incentive plan arrangements, it's important that companies understand the accounting implications of any incentive arrangement. Important terms impacting the accounting treatment of any plan include the manner of settlement, the timing of settlement and the conditions of settlement, which can have varying and significant impacts both from a financial reporting perspective and in terms of future costs where the accounting standard may require annual valuation exercises to be performed. 

It is also important to under the disclosure requirements under each of these standards in terms of what scheme information will be presented within the financial statements.

Understanding the effects of conditions on your plan will enable you to make informed decisions regarding the accounting implications of implementing your incentive plan.

Safeguarding the business and protecting founders and majority shareholders

An employer should not underestimate the importance of seeking appropriate legal advice when implementing any type of incentive plan, particularly where shares will be issued. The legal paperwork must be clear on the rights and powers of both the company and the employee concerned in all circumstances, e.g. on an Exit, on a Change in Control, on Cessation of Employment etc.

The introduction of minority shareholders into a company can cause difficulties in terms of how the company manages its business going forward. There are ways to manage how, when and for how long such minority shareholders will exist, and it is important to consider the implications of all these matters where equity plans are being considered.

Are incentive plans right for your business?

If you're considering implementing an incentive plan for some or all of your workforce, bear in mind there can be complex tax, legal, valuation and accounting issues to consider, particularly when the plan involves the issuance of shares. 

 It's vital to safeguard the business and protect founders and majority shareholders at all times. Make sure you get professional legal, tax, valuation and accounting advice. 

Is it time to consider the implementation of an incentive plan for your business? Kick-start the process by trying to answer these questions. 

  1. Is there an appetite to give equity away?
  2. If there is, is there an appetite to give that equity on day 1, or do you want the person to have to earn it or the ability to take it back?
  3. What type of performance metrics would you like to include?
  4. Is there an exit planned? If so, what sort of exit, and when do you expect it to happen?
  5. Is there a recent valuation of the shares available, or would one be required? 
  6. What happens if someone leaves their job? Will you honour the incentive plan promise?
  7. What happens if there's a change of control in the business before the plan vesting date? 
  8. How much value are you willing to give away in the business (whether in % shareholding terms or overall cash terms)
  9. If it will be a cash-based plan, do you know what the maximum cash pool in a given year would be? This is based on your profits. 

Get expert advice

Remember, our multidisciplinary Private Enterprise team is always ready to advise and support you as you seek to grow your business. Find out today how our Private Enterprise team can help you with employee share incentives plans.

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