Employee incentives play a crucial role in retaining talent, boosting motivation, and aligning staff with company goals. While cash bonuses and benefits packages are common, share-based incentives can provide long-term value to both employers and employees. In this blog, we’ll explore various employee incentive options, the tax implications of share awards, and key considerations when structuring such schemes. Also read our guide on issuing Share Options

Why Employee Incentives Matter

Imagine Sarah, a hardworking marketing executive, who was thrilled to receive a £10,000 year-end bonus. However, her excitement faded when she realized how much of it was lost to tax deductions. Could her employer have done something differently to maximize her reward? Absolutely! Let’s explore the options.

1. Non-Share Incentives: Exploring Traditional Options

Companies often think of salary increases or cash bonuses to reward employees. However, several other non-share incentives provide long-term benefits and encourage employee loyalty.

a. Cash Bonuses: A Quick Win with Hidden Costs

Example: A marketing firm awards its top-performing sales employee a £10,000 year-end bonus.

Tax Impact:

• Subject to 40% income tax, reducing the net bonus to £6,000.
• Employer National Insurance at 13.8%, adding an extra £1,380 cost to the company.

Consideration: Bonuses provide immediate gratification but can be costly due to tax deductions.

b. Benefits in Kind: Perks That Feel Like Pay

Example: An IT company provides a senior manager with a company car valued at £30,000.

Tax Impact:

• The benefit-in-kind (BIK) value is assessed based on CO₂ emissions, leading to a potential taxable amount of £9,000 annually.

Consideration: Offering perks such as flexible work arrangements can be more tax-efficient.

c. Pension Contributions: Investing in the Future

Example: A law firm contributes £15,000 to an employee’s pension annually.

Tax Impact:

• No immediate tax for the employee; contributions grow tax-free until withdrawal.
• Corporation tax relief for the employer.

Consideration: This option provides long-term security and tax efficiency.

d. Flexible Working: Work-Life Balance Boost

Example: A digital agency offers a four-day workweek without pay reduction.

Consideration: No direct tax implications but enhances work-life balance and productivity.

2. Share-Based Incentives: A Deeper Dive into Awarding Shares

These incentives align employees’ interests with the company’s long-term success by giving them a stake in the business.

a. Employment Related Securities (ERS): More Than Just Shares

Example: A tech startup awards 5% of its shares to a key developer.

Tax Impact:

• Income tax applies on the value at the time of issue if deemed employment-related.

Consideration: Proper structuring helps minimize tax liabilities.

b. Readily Convertible Assets (RCA): Watch Out for the Traps

Example: A company awards shares to an employee when they are in talks with a potential buyer.

Tax Impact:

• Immediate PAYE and NI charges based on market value.

Consideration: Early planning can help avoid tax surprises.

c. Valuation Considerations: Knowing Your Worth

Valuation of shares is critical in determining tax implications.

Example: A retail business issues 10% shares to a director, applying a 60% minority discount.

Tax Impact:

• The discounted value of £400,000 is used for tax purposes.

Consideration: Applying valuation discounts strategically optimizes tax efficiency.

3. Restricted Securities: Protecting Employer Interests

Shares with restrictions, such as forfeiture clauses, ensure employees remain with the company long-term.

Example: A manufacturing company requires employees to sell shares back at nominal value if they leave.

Tax Impact:

• Tax is based on actual market value rather than unrestricted value.

Consideration: Restrictions protect the company but require proper planning.

4. Alphabet Shares: Flexibility in Ownership

Alphabet shares allow businesses to distribute dividends differently across shareholders without changing ownership proportions.

Example: A consultancy firm issues A, B, and C shares with specific dividend entitlements.

Tax Impact:

• Flexible dividends allow tax-efficient distributions.

Consideration: Compliance with tax rules is crucial to avoid disguised remuneration.

5. Dividend-Only Shares: A Double-Edged Sword

Dividend-only shares provide a way to share profits without giving voting rights but carry risks if structured improperly.

Example: A business owner issues shares to their spouse, allowing dividends but no voting rights.

Tax Impact:

• HMRC may treat dividends as part of the owner’s taxable income.

Consideration: Clear commercial rationale is critical to avoid tax scrutiny.

6. Growth Shares: Rewarding Performance

Growth shares incentivize employees by rewarding them based on future business growth.

Example: A software company awards growth shares to a senior manager participating in value above £5 million.

Tax Impact:

• No immediate tax charge as shares have no value at issuance.

Consideration: Aligns employee incentives with business performance.

7. Reporting Obligations: Staying Compliant

Companies must report share awards to HMRC to ensure compliance and avoid penalties.

Example: A business issues shares without filing the required ERS returns.

Tax Impact:

• Potential penalties and scrutiny from HMRC.

Checklist:

• Submit ERS returns by July 6th.
• Maintain records for due diligence.

8. Practical Considerations for Employers

Before implementing share incentives, employers should:

• Conduct due diligence to align incentives with long-term goals.
• Assess potential tax risks and valuation complexities.
• Consider the impact on employee retention.

Conclusion

Employee incentives, particularly share-based schemes, can be powerful tools for aligning interests and driving business growth. However, careful planning and adherence to tax legislation are crucial to avoid unintended liabilities. Whether opting for cash bonuses, pensions, or share awards, businesses must weigh the costs and benefits to create an effective incentive structure.