Pluses and pitfalls employee share schemes
Thursday, January 24, 2008/
Employee share schemes not only provide a way to engage employees in the success of the business, but they can be a tax effective way of delivering benefits to employees. By MIKE PRESTON.
By Mike Preston
There are many advantages to employee share schemes – not only do they provide a way to engage employees in the success of the business, but they can be a tax effective way of delivering benefits to employees.
But there are some tricky issues associated with implementing the schemes that business owners need to be aware of, and that apply particularly to SMEs.
A key benefit given to employees who receive discounted equity in the business they work for via an employee share scheme is the ability to defer payment of tax on the shares until they are sold.
There is also a $1000 tax free threshold on the value of the shares – in effect, the employee only pays tax on the value of the shares above $1000.
- The shares are given in a company that is the employer of the employee or the employer’s holding company.
- The shares available under the employee share scheme are ordinary shares.
- When the share was acquired, at least 75% of the permanent employees of the employer were or had been entitled to acquire shares under an employee share scheme of the employer or its holding company.
- After acquisition of the share, the employee does not hold an interest of more than 5% of the shares in the company.
- After acquisition of the share, the employee was not in a position to cast, or control the casting of, more than 5% of the votes at the company’s general meeting.
For publicly listed companies, once these hurdles are overcome it is more or less smooth sailing to implement an employee share scheme. For unlisted companies, however, there are a series of further difficulties that need to be understood and dealt with, while business with non-company structures cannot take advantage of the rules.
Martin Morrow, a partner specialising in equity based compensation and remuneration with KPMG, says he has seen private companies with annual turnover as little as $20 million successfully implement share schemes.
Morrow says there are four key issues smaller unlisted companies must overcome:
- How do you realise the value of the shares: the biggest issue unlisted companies must overcome in implementing employee share schemes is to put a sound mechanism for selling the shares in place, Morrow says.
For larger unlisted companies, this can mean setting up an internal share market that would enable employees to sell shares to each other.
Smaller companies, however, may need to utilise some form of buy-back scheme to ensure employees are able to sell their shares.
- How do you calculate the value of the shares: Listed companies have no problem calculating the value of shares given to staff – they just have a look at the ASX. But how do you work out the value of shares in an unlisted company?
Morrow says it is vital to set out a clear valuation mechanism when shares are allocated that will be consistent between all employees. He says a common system is to link the value of shares to a given multiple of earnings or profit.
- When can employees sell: Most employee share schemes impose some limitation on when shares can be sold. Morrow says a common mechanism provides an annual window during which shares can be bought or sold, but many companies also provide shares to be relinquished upon termination.
- Ongoing costs: Employee share schemes are not a ‘set and forget’ way of remunerating employees. Especially for unlisted companies that have to establish and maintain internal markets, there are ongoing administrative, accounting and legal costs.