A popular way to reward employees is to offer them shares in your company. One way you can do this is to set up a scheme called a Share Incentive Plan or SIP. Under a SIP, you can give shares to employees or allow them to purchase them from their pre-tax income. While SIPs do take time to set up and need to be administered year-on-year, employees like them. They’re most suitable for listed or larger, private companies.
In this guide we take a look at how SIPs work, and their tax-advantaged features.
- What is a share incentive plan (SIP)?
- What legislation do you need to be aware of in relation to SIPs?
- Eligibility criteria to participate in a SIP
- Share incentive plans: guidance for employers
- How to put together a share incentive plan
- What administration needs to be taken care of?
- What are the tax implications of a SIP?
- What are the advantages/disadvantages of SIPs?
What is a share incentive plan (SIP)?
A Share Incentive Plan is a scheme that many employers use to provide an additional layer of rewards for their employees. If you want to offer your staff shares, one of the most tax-efficient ways to do so is via a SIP.
Setting up a SIP can be complicated, so you will need the help of a lawyer to draft the plan documents. The scheme will need to be administered properly year-on-year to ensure you secure the tax advantages. A SIP is set up as a form of trust, administered by independent trustees. The shares must stay in the plan for at least three, and for up to five, years in order to qualify for full tax benefits. Shares may be one of the following types:
- Free shares. You can give your employees up to £3,600 worth of shares every tax year, provided you give them to all employees on the same terms. If your employee leaves before the qualifying three-year period, their shares can be lost.
- Partnership shares. Employees can buy up to £1,800 worth of ‘partnership shares’ from their pre-tax and NIC salary every year. The employer won’t pay NIC on the purchase price.
- Matching shares. Employees can offer employees matching up shares of up to two shares for each partnership share bought.
- Dividend shares. Employees holding SIP shares can use any dividends they receive on those shares to buy new shares.
What legislation do you need to be aware of in relation to SIPs?
In order to qualify as a tax-advantaged share plan, your SIP must meet the requirements of the SIP code including the requirements of Schedule 2 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA). You must tell HMRC about it and confirm that it meets the statutory tests to be a qualifying plan. HMRC may check with you that your SIP complies with the SIP code.
Here is a full list of the relevant legislation:
- Chapter 6 of Part 7 of ITEPA
- Schedule 2 to ITEPA
- Part 1 of the Taxation of Chargeable Gains Act 1992
- Section 95 of the Finance Act 2001
- Sections 392 to 395, 405 to 408 and 770 of the Income Tax (Trading and Other Income) Act 2005
- Chapter 5 of Part 9 of the Income Tax Act 2007
- Chapter 1 of Part 11 of the Corporation Tax Act 2009
Eligibility criteria to participate in a SIP
If you wish to set up a SIP, both your company and the beneficiaries must meet certain eligibility criteria. Your company must be an independent private company or a listed company for example, and you must invite all of your UK tax resident employees to join on the same terms. The shares offered must be ordinary shares that are fully paid up and non-redeemable.
Share incentive plans: guidance for employers
- When you set up a SIP, you can offer free shares, partnership shares, or a combination of both. You can also offer matching shares and dividend shares. So long as your employees stay with you, their shares will be held under a trust that qualifies under the requirements of the SIP code. When they leave, their shares will come out of the SIP automatically.
- Provided that your SIP qualifies under the legislation, then the SIP will be ‘tax-advantaged’ – if they remain in the SIP for between three and five years, they will be fully or partially free of income tax and NICs. If they rise in value, no capital gains tax will be payable.
- To set up a SIP, your company must be independent, listed, owned by a listed company, or subject to an employee-ownership trust.
- You must offer ordinary, fully paid-up, non-redeemable shares.
- Employees that are UK tax resident must be invited to join. Qualifying employees must be employed by you, and if you set a minimum period of employment, have been employed for that length of time.
- Your offer must be made open for 14 days and have 25 days to opt out if they wish.
- All employees must be invited to join the SIP on identical terms. If you have a group of companies and want to offer different terms, each company in your group must set up an individual SIP.
- If you decide to set a minimum period of employment before an employee is eligible to participate in a SIP, this must not be more than 18 months, and you can set different periods for each type of share award (free and/or partnership for example)
- You must set up a UK-based trust to hold the SIP shares.
- You will choose a trustee to administer the trust (often a professional body) that will keep records and correspond with the plan participants and file returns with HMRC. You can set up a company to administer the trust if you want to, although this can be burdensome and expensive to administer.
- You can’t offer cash instead of shares or select different categories of employee who may participate.
- You can give up to £3,600 worth of free shares in any tax year, and to remain tax-advantaged, employees must hold them for between three and five years.
- Employees can buy partnership shares of up to £1,800 in each tax year, paid for out of their earnings.
- Partnership shares will be governed by a partnership share agreement that your company will enter into with the SIP trustee. This agreement will cover how shares are paid for and when, and the terms on which employees may stop and start their payments and give them the right to pull out if they wish. The partnership agreement must also contain specific wording so should be drafted by a professional.
- You can choose to limit the number of shares you offer employees.
- If you decide to offer matching shares, these must be the same type of share as those purchased, and the maximum you can offer is two shares for every share bought. These must be held for between three and five years and are withdrawn from the SIP if the employee leaves.
- Dividend shares must be of the same type of share as those that attracted the dividend. You can either make dividend shares compulsory or offer employees the chance to opt-in or opt-out of dividend shares. These must be held for three years and are taken out of the SIP when the employee leaves.
- When an employee leaves, their shares leave the SIP.
- Your costs to set up the SIP are deductible for corporation tax, as is the market value of any matching shares you offer.
How to put together a share incentive plan
Drafting key documents
In order to set up a SIP, you will need to put together a trust deed, a set of rules for the SIP, and certain other documents such as a partnership share agreement and free share agreement. You will then certify to HMRC that your plan meets the SIP code requirements.
When you have set up your SIP, you must tell HMRC by 6 July of the following tax year and certify that your plan meets the necessary qualifying requirements.
You must appoint a trustee to administer your trust. This can be a professional body, or you can set up a company to administer the SIP for you, and act as trustee.
If you need to agree the market value of shares with HMRC, you need to submit a special application form and agree with HMRC the methodology you have used to calculate it.
Because existing shareholders can be diluted by the existence of a SIP, you may need to get their approval if you want to set one up. To find out if you need shareholder approval, you will need to review your Articles of Association and any shareholders agreement that’s in place. Listed companies on the Main Market normally need the consent of their shareholders before setting up a SIP, but those on the AIM normally do not.
Any share capital issues
While existing shareholders are normally protected by law against their shares being excessively diluted, shares offered under employee share schemes are exempt, and shareholders won’t be offered the right of first refusal over the employee shares.
What administration needs to be taken care of?
Your trustee will need to file an annual return to HMRC on your behalf by 6 July of each tax year, and there are penalties for failing to comply. Your trustee will also need to administer the scheme documents, communicate with employees, and take care of the administration relating to joiners and leavers.
What are the tax implications of a SIP?
Employees buy partnership shares out of their pre-tax income. They won’t pay any income tax or NICs provided they hold their shares for at least five years. If they take shares out of the SIP after five years, they won’t pay CGT if they sell the shares immediately but will pay CGT on any gain that occurs from the date the shares are withdrawn.
If an employee withdraws shares within three years from the date they acquired them, they will pay income tax and NIC on those shares.
If an employee withdraws shares between three and five years, they will pay tax and NIC on the lower of the market value of the shares when they are withdrawn, and the salary they used to buy the shares (or the market value of their shares when they become entitled to them in the case of matching and free shares).
If an employee withdraws shares from a SIP in the case of their death, injury, disability, redundancy, retirement or TUPE transfer, there will be no income tax payable.
You will get corporation tax relief on the employee’s payment for the shares, the costs of providing the partnership shares, the market value of any matching or free shares, and your admin costs to administer the scheme.
What are the advantages/disadvantages of SIPs?
- Your costs to set up and administer the plan as well as the cost to provide free and matching shares are tax deductible.
- There are tax advantages to your employees when acquiring shares.
- You can attach performance conditions before an employee qualifies for shares, and this can be a powerful incentive.
- Having a SIP in place can discourage employees from leaving, as they will lose their tax advantages.
- SIPs can be expensive to set up and administer and are more complicated than simply paying a salary to staff.
- The value of shares can drop, and an employee may lose their money if your company fails.
- Employees may resent the fact that they need to remain in employment to qualify for tax treatment, and this can affect morale.
- Employees who leave may have to repay income tax and/or NIC relief.
- You may end up giving away more equity than you, or your shareholders, would like.
- You will need a corporate specialist to set up and operate your plan.