In today's times of skilled labour shortages, employers are looking for ways to make their positions more attractive or retain key employees. To this end, there are a number of employee incentive and benefit programmes. One interesting motivation option may be so-called employee stock programmes. In the following article, we introduce you to their basic aspects.
When we talk about employee share schemes, we usually mean employee participation programmes. Simply put, this is a scheme that allows employees to acquire a stake in a company, typically in the form of shares, on more favourable terms than the market. Such a system can also be established in other business corporations (e.g. limited liability companies), but public limited companies are best placed to take advantage of it.
The advantage of employee participation schemes is the significant long-term incentive component, the so-called ownership mentality. It is in the employee's financial interest for the company to prosper in the long term, and so the employee is motivated to stay with the company to maximise the benefits received.
Examples of employee participation programmes in practice include:
- option plan;
- direct sale of shares;
- shadow shares.
As employee share ownership plans often involve considerable sums of money, it is essential that they are set up correctly from the point of view of taxation and social and health insurance contributions. Benefits accruing to employees from such schemes are always treated as employment income in the first instance. This is because they are clearly linked to employment.
In the second phase, income from the holding or sale of shares is classified as capital and other income, i.e. outside employment. It is only here that the possibility of exempting income comes into play.
To set up the tax scheme correctly, it is then necessary to identify the moment of taxation and to determine the amount of income to be taxed. This will depend especially on the type of employee scheme, which we comment on in more detail below.
Finally, the method of taxation of the income (through tax paid on wages or through a tax return) and whether such income is subject to social security and health insurance contributions are assessed. This involves a detailed analysis of the setup of the plan and the relationship between the entity to which the shares are acquired, the legal employer and the employee.
The essence of the option plan is the option right, which means the right to buy back the company's shares at a pre-agreed (discounted) price in the future. However, this is only a right; the employee is not bound by the obligation to buy back the shares. Employees generally acquire the right to buy back shares gradually during the course of their employment.
In the normal setup of an employee stock option plan, taxation and any social security and health insurance contributions are usually due upon exercise of the option, at the time the shares are credited to the employee's investment account. Income is taxed at the difference between the market value of the stock at that time and the purchase price paid by the employee.
Direct sale of shares
Unlike an option plan, where the employee has only the right to exercise the option, the parties may also agree to sell shares outright at a pre-agreed (discounted) price. This option usually comes at the beginning of the employment relationship or soon after it, but a gradual release of shares is not excluded.
In this participation scheme, taxation and possible social security and health insurance contributions are due when the shares are credited to the employee's investment account. Income is taxed at the difference between the market value of the share at that time and the purchase price paid by the employee.
Shadow shares operate similarly to an option plan, except that the employee is gradually entitled to a cash award corresponding to the appreciation of the share from an agreed point in time, based on an internal or contractual mechanism. Thus, employees never become shareholders. The company is only contractually obliged to pay them the amount corresponding to the share appreciation at a certain point in time as a bonus on top of their salary.
In the case of a shadow share scheme, employees do not actually acquire securities; the value of the cash award is merely derived from them. The income and any social security and health insurance contributions are taxed at the time of settlement or payment of the full amount of the cash award.
If a company decides to apply an employee participation scheme, it is prudent to bear in mind some basic conditions that define the rules under which the scheme will be implemented. In particular, our recommendations are:
- Limit the volume of shares that will be used for the programme (10-15%).
- Reserve the right to unilaterally change certain parameters of the programme.
- Define what shareholder rights are attached to the shares (profit share x voting rights).
- The right of the company to buy back the shares acquired from the employee at market price, e.g. in a bad leaver situation.
- Restrict (or completely prohibit) the transfer of shares to third parties or encumber them (e.g. pledge).
- Assess the tax implications of the scheme in detail and communicate them appropriately to employees.
While participation programmes are not and cannot be the only way to attract motivated and valuable employees, they can be an attractive benefit that such employees will want. However, the programme needs to be carefully tailored to the specific company.