Reviewing your Reward Strategy - Don't Forget to Consider All the Alternatives

By Gearóid Deegan
First published in  Irish ProShare Association (IPSA) Newsletter
Summer 2009
Reproduced by permission

Responding to the current challenging economic climate, employers across all business sectors have been reviewing employment costs.  In many instances this has led to a pay freeze or a reduction in pay.  Employees have also suffered with the new income levy and increased health levy this year.  Bonus payments are unlikely to materialise for many organisations in 2009, in sharp contrast to the position which as prevailed over recent years.  Other employers have had to introduce a mix of reduced working hours, unpaid leave arrangements and, unfortunately, the ultimate step of reductions in headcount.

The one certainty, however, is that the economy will turn around and employers need to be well positioned to take full advantage of the up-turn when it does come.  Some of the most forward thinking organisations have already begun reviewing their reward strategies to ensure they both underpin and promote the overall business strategy.  As part of this planning for the future, companies should not overlook the significant advantages associated with share incentives.

It is a well established principle that employers who operate a correctly structured employee share incentive often outperform those organisations which do not utilise shares as part of their reward strategy.  At a time when share prices generally are somewhat depressed, there is potential for significant upside where performance improvements can be delivered.  However, the key for most companies today is in ensuring the gains are delivered to those individuals who play their part in driving the business through the current economic cycle and indeed beyond.

Companies now reviewing future bonus arrangements should consider the right balance between cash and shares.  Share awards currently have the added benefit of not attracting any employers PRSI charge.  This can deliver savings close on 11% of the aggregate value when compared to a straight cash bonus.

The introduction of the increased income levy (at up to 6%) and the health levy (up at 5%), has had the direct effect of reducing net take home pay.  Under current tax rules, shares delivered under Revenue approved schemes are exempt from tax.  In addition, such share awards are not liable to either the income or health levies.  So, while cash awards are liable to ‘tax’ deductions of up to 52%, plus the additional employers’ PRSI cost of almost 11%, Revenue approved share awards are completely tax free and currently have no employers PRSI cost.

By utilising such incentives through a performance related share plan, employers can deliver greater after tax value to employees and at a much reduced cost to the business.  That has to make sense in the current climate, even before one considers the positive impact on employee morale that could manifest itself as businesses turn the corner in this economic cycle and share prices begin to recover.

The most popular Revenue approved share plan is perhaps incorrectly known as a ‘profit sharing’ scheme.  There are over 510 such schemes approved in Ireland, across all industry sectors.  These range from indigenous Irish companies to subsidiaries of multinational companies.  These employers can offer employees shares up to an annual value of €12,700 on a tax free basis.  Where the shares can be funded from an existing performance related discretionary bonus arrangement, it has the potential to be very cost effective for employers.  It may also be possible to deliver such share awards through an existing performance based appraisal system thereby ensuring employers are getting value for money with their employment costs.

The second most popular Revenue approved scheme is the all employee ‘SAYE’ scheme.  There are around 140 such schemes approved in Ireland.  These schemes are used to grant employees share options at a discount of up to 25% of the current share value.  Through a linked monthly savings scheme, employees save the discounted option price over a three or five year period.  Thereafter they have the funds to exercise the option, but the upside is there is no tax to pay on the value of the shares so acquired.

Where employers wish to tie in employees and restrict their ability to sell shares for a time period, it is also possible to deliver both tax efficiencies for the employee and cost savings for the employer.  For example, where an employee is restricted from selling share awards for a period in excess of five years, the taxable value is reduced by 60%.  So instead of paying taxes at over 50% on the full value of the shares, the taxable value is reduced such that the effective tax rate falls closer to 20%.  In addition, there is a significant employer PRSI saving when compared to a deferred cash bonus award.

There are various other forms of share incentive arrangements, either all inclusive or discretionary in nature.  However, each company would need to consider which structure best suits its particular needs and supports the business strategy.  If one accepts the concept that employee share participation can be a positive business driver, then it would be remiss not to explore such arrangements as part of any review or reward strategy.