SIPs were initially introduced in 2000 as all-Employee Share Ownership Plans and rebranded in 2001 as SIPs. They provide all employees with an opportunity to own shares in their employing company or, if a group of companies, in the parent company.
There is flexibility within the SIP for the employer to design their plan to offer free shares to employees, or for employees to purchase shares out of their gross pre-tax income and thus acquire shares in a tax efficient manner.
It is possible to award shares with performance conditions attached, although these must be objective to ensure it remains an all employee share plan.
What is a SIP?
SIPs, which are commonly used by listed companies, are an HMRC approved share acquisition plan designed to encourage employees to own shares in their employing company and to participate in the growth of the company. The plan must be set up in conjunction with a trust. The employee can be granted shares subject to annual limits: free shares with a market value at the date of award of up to £3,000 per tax year; purchased shares ('partnership' shares) up to £1,500 per tax year (used to purchase shares at the lower of the market value at the beginning of the accumulation period if there is one, and the market value at the date of acquisition), with the possibility of the company providing further free matched shares up to a maximum of 2 matched shares for each one partnership share (i.e. a limit of £3,000 for matched shares); and dividends reinvested into shares up to £1,500 per tax year.
Why use a SIP?
The main benefit of the plan is that employees can either acquire shares in the company out of gross, pre-tax income, or be provided with free shares without incurring an income tax liability as long as the shares are held in the trust for the prescribed time.
Employees appreciate both the tax efficient nature of the plan and the opportunity to participate in the growth of the company which in turn can have a positive impact on motivation and retention.
How does a SIP work?
All employees are offered the opportunity to obtain shares though a number of alternative methods as outlined above.
An individual plan can offer a combination of these alternatives.
The free and matched shares must be held in a trust for a period of at least 3 and not more than 5 years beginning with the date the shares are awarded to the employee. The shares must be held for the required holding period to maximise tax efficiency.
Under both UK GAAP and IFRS the SIP will be regarded as a share-based payment arrangement.
Share-based payment arrangements can be either "equity-settled" or "cash-settled".
When the SIP is accounted for as an equity-settled arrangement, the charge to the profit and loss account is calculated by reference to the fair value of the shares at grant date determined using an appropriate financial model. The period over which the charge is made will be determined by the terms of the arrangement.
When the SIP is accounted for as cash-settled, the fair value of the future liability is re-measured at each reporting date and again at settlement. Advice should be sought as it is not always certain which accounting method will apply and this may vary between the group and subsidiary level. Although the shares will be held in a separate trust, both UK GAAP and IFRS require that the shares are reflected in the accounts of the company.
The employer will usually qualify for a corporation tax deduction for contributions made into the trust in relation to free or matching shares.
Income Tax and NIC
If any of the shares acquired or awarded in the plan are held within the trust for at least 5 years, there is no income tax or national insurance due when the shares are withdrawn.
If the free or matching shares are held within the trust between 3 to 5 years there is an income tax charge on the lower of the market value of the shares at the date of the award and the market value at date of withdrawal, unless they are removed under certain limited circumstances. If partnership shares are held within the trust between 3 to 5 years, the amount counting as employment income is the lower of the cash used to buy the shares and the market value of the shares at date of withdrawal.
If any of the shares are held within the trust for less than 3 years income tax will be charged on the market value at withdrawal, again unless they are removed under certain limited circumstances.
If the company is listed or has a market for the shares, any income tax will be collected through PAYE and national insurance will also apply.
Dividends received by the trust are exempt from tax if the relevant shares are awarded to the participants within five years. This is reduced to two years if the shares are listed.
Dividends reinvested into shares are not treated as taxable income of the employee. Cash dividends that are not reinvested but paid to the employee are taxed as dividend income on the employee.
Capital Gains Tax
On the sale of the shares, the increase in the value above the value of the shares when leaving the plan is taxed under the more favourable capital gains tax regime. (Note there is no requirement to withdraw the shares from the plan within a specified time limit)
For whom is a SIP suitable?
The use of a SIP is particularly attractive to the following types of employers:
- Companies seeking to align the employees' interests with those of the company and other shareholders to ensure growth.
- Companies seeking to encourage wide share ownership across employees.
How we can help. We can:
- prepare the rules and trust documentation;
- obtain the required advance approval of the scheme from HMRC;
- obtain HMRC agreement on the valuation of the market value of shares;
- act as trustees under the Plan;
- administer the Plan;
- operate trustee bank accounts required by the Plan;
- assist with communication of the plan to employees;
- assist with the annual Form 34 return.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.