The objectives of employee share plans include growing value of the company and providing a mechanism to enable employees to share the increased value at some time in the future; and this is tied in with the need and the mechanism for retaining the best staff for the longest term possible.
Umbrella principle
Principle 9 of the ASX Principles of Good Corporate Governance and Best Practice Recommendations (applicable to Public Companies and of interest to other companies) states that a company should ensure that the level and composition of remuneration is sufficient and reasonable and that its relationship to corporate and individual performance is defined.
This means that companies need to adopt remuneration policies that attract and maintain talented and motivated directors and employees so as to encourage enhanced performance of the company. It recognises that executive remuneration packages should involve a balance between fixed and incentive pay, reflecting short and long term performance objectives appropriate to the company's circumstances and goals. A proportion of executive directors' remunerations should be structured in a manner designed to link rewards to corporate and individual performance.
Variety of methods
Methods of enabling employees to share the increase in the value of a company range from Share Plans, Option Plans through to Non-Share Participation Plans (Phantom Share Plans). The Phantom Share Plans relate to proprietary companies only. The Share Plans and Option Plans are available to both private and public companies.
However, each involves a set of Share Plan Rules an information booklet or note and forms for applications for shares and option exercise forms. In some cases standard loan agreements are attached where the company decides to lend the executive the share purchase money.
Generally in a share plan, you will find that:
- The company will have discretion as to who to issue shares to and this discretion will be exercised by the Board.
- A public company will generally only issue ordinary shares.
- A private company may attach conditions to the shares (ie. no voting rights).
- The company may issue shares for no consideration or for a predetermined consideration.
- Trading restrictions may be imposed on shares issued under a share plan of a public company.
- The company usually makes an offer to an employee containing particulars and there may be a minimum or maximum share take up. The offer should refer to the amount payable (if any) for the shares on the return of the application.
- A company will usually restrict shares to be issued under a share plan to a minimal percentage of shares issued in the company.
- With a public company, after issue of shares they will rank equally for dividends declared on or after the date of allotment. This may not be as important with a private company because dividends are often not declared. Here, the participant will be looking for the increase in the value of the shares more than to a dividend.
- There is generally a drag along clause if there is a takeover offer for the company which forces the employees to transfer their shares in those circumstances.
- Generally a Share Option Plan will involve eligible employees being given options to exercise within particular time parameters to obtain shares in the future. The offer will contain Terms and Conditions in relation to price and acceptance. For example, with a private company the option holder may be deemed to be bound by a shareholders agreement when the option is exercised and shares are acquired.
- The rules contain conditions about what will happen on the dismissal or retirement of a shareholder or option holder.
- A company may assist certain eligible option holders by way of lending them funds to acquire shares.
- Often plans include a condition that the participant appoints the chairman of any meeting of the company as his or her proxy to attend and vote. More often than not, a participant in a private company share plan will not have the right to attend meetings unless invited in writing.
- Plans may contain certain triggers which will allow optionholders to take up shares for example, a percentage or increase of percentage of return on investment for shareholders.
- There are taxation implications for optionholders and shareholders.
Phantom share plans (performance award plans)
In these plans the employee does not actually get shares. He/she gets the equivalent of holding shares. These plans are attractive to closely held companies which may not want to issue shares as part of employee incentive.
- Structured to provide employee with bonuses on achievement of certain performance targets;
- Level of bonuses reflect level of return the employee would receive if he/she held shares.
- Intended to reflect current earnings of employer and an increase in overall value of the employer company.
- Such a right is a contractual right of the employee to receive bonuses at certain times. Level of bonuses is determined by reference to the extent to which the employee has satisfied certain key performance indicators.
- Benchmark bonuses will be identified, for example EBITDA in a financial year or increase in value of employer over financial year.
- Level of bonus payable will be determined by multiplying benchmark bonus by a benchmark bonus percentage.
- Bonus percentage determined by identifying each of the KPIs the employee has satisfied and adding up relevant percentage amounts.
- For a golden handcuff effect, payment may be deferred under the plan.
- With this type of plan, tax is only paid upon actual receipt of entitlement.
Taxation
If a share is paid for by an employee at full price there is no tax implications at time of take up.
If there is a discount, ordinarily the discount is included in the assessable income in the year the share is acquired.
A discount on what is called a Qualifying share is included in the assessable income at the cessation time of the share.
A Qualifying Share is an ordinary share acquired under an Employee Share Scheme where at least 75% of permanent employees are entitled to acquire shares and the taxpayer holds less than 5% of the shares in the company.
Cessation time is either disposal, when employment ceases or ten years after acquisition.
There is an exemption of up to $1,000 of discount for tax purposes:
- If employee elects to be taxed in the year of acquisition;
- Where the share plan prohibits disposing of the shares inside three years; and
- Where the share scheme is not discriminatory.