The options presented to the Tax Strategy Group to allow SMEs compete in the war for talent are right on the money

Tom Maguire discusses the Key Employee Engagement Programme (KEEP) in his Business Post column

Much has been written about the “will they, won’t they” enact a 30% rate of income tax which would slot in between the current 20% and 40% rates. The recently released Tax Strategy Group (TSG) Budget 2023 papers outlined some of the issues there although that would be a good move in reducing the impact of the cost-of-living crisis.

The TSG is a government think tank chaired by the Department of Finance. The website explains that the group “is not a decision-making body and the papers produced are simply a list of options and issues to be considered in the Budgetary process”.

The TSG papers discussed various other issues across a number of areas and tax heads. For example, the income tax paper weighs in at over 70 pages, the corporate tax one comes in at nearly 50 pages. Here we’ll specifically look at an issue I have discussed many times in these pages: employee share options. The aim of the Key Employee Engagement Programme (KEEP) is to help smaller firms who can’t compete with larger firms in cash remuneration terms to retain and attract employees. It allows them reward staff with shares providing them with “skin in the game” in their companies.

KEEP provides an exemption from income tax, USC and PRSI on any gain realised on the exercise of a qualifying share option. Instead, the gain will be subject to Capital Gains Tax on a subsequent disposal of the shares. This deferral of the tax until point of sale when the employee has cash resources to pay the tax liability is the main positive of KEEP as well as potentially a lower tax rate currently. However, KEEP’s take up has been low.

The TSG papers explains that to be eligible, firms must employ fewer than 250 employees and their annual turnover / annual balance sheet cannot exceed €50 million and €43 million respectively. The paper outlines the participants comprising 27 firms with between 11 and 50 employees, 19 with less than 10 and only 4 firms with between 51 and 250 firms. So you can see the number of firms participating is small.

For example, of the above in 2020, 20 companies engaged in IT and computer services, while manufacturing and holding companies had 6 companies each. But in terms of human beings, 227 employees were granted share options in 2021 with a total market value of €1.1m, and 43 employees exercised share options. That’s why the Department initiated a public consultation earlier this year and the TSG papers outline what the survey responses saw as improvements to KEEP.

These included such matters as a continuation of the scheme beyond its current sunset date of 31 December 2022 with the suggestion being to end of 2025. The TSG paper notes in relation to this suggestion was that “strong support exists for the scheme, and that it has a relatively modest cost”. You can see the point, but that wouldn’t be enough in that without other changes the regime may continue at its existing levels.

There are also the valuation requirements i.e., that the share options have been granted at market value, that each employee’s entitlement does not exceed the relevant annual/lifetime limit and that the aggregate issued but unexercised share options do not exceed the €3 million company limit. Here the TSG paper explains some suggestions being (1) Revenue to provide safe harbour for valuations (like HRMC does for its Enterprise Management Incentive scheme), (2) Revenue to provide more guidance on appropriate methodologies for undertaking share valuation (with examples) and guidance on how long a valuation remains “in date” (i.e. from last funding round / last professional valuation), and (3) in instances where Revenue disagrees with the valuation, then ensure that only the value of share options in excess of the threshold market value at date of grant will be non-qualifying for the scheme’s purpose. That would mean an income tax charge only arises on the undervalue amount, rather than the entire application.

The paper outlines counters to all of the above. In terms of the first potential option, significant additional resources would be required if Revenue were to approve such valuations. On the second potential option, this would be an operational matter for Revenue and would not require legislative changes. On the third option, it may be desirable for some penalty to exist to discourage unduly low valuations from firms of their shares.

Let’s be fair here, these are not unreasonable counters but these are all issues which could be dealt with. A perfect regime will never exist as there will always be opponents on both sides. Taxpayers will disagree with Revenue disagreements but the need for perfection should not stand in the way of the good. KEEP’s aim is to allow ‘David’ companies to appropriately compete with the ‘Goliaths’ to society’s benefit.

The TSG explained that the consultation responses noted the lack of a liquid market for the sale of SME shares making it difficult for employees to see the value of share options if they cannot envision selling them in the future. A buyback of shares can be treated as income with the higher rates of income tax applying. The suggestion was to change the law to reflect that KEEP shares could have CGT treatment applied. The concern noted was that this could facilitate undesirable tax planning arrangements. Our tax laws have many anti-avoidance provisions which the courts have interpreted as requiring that a tax benefit should be the “icing on the cake” with the cake being the commercial benefit (i.e. David competing appropriately with Goliath as above). So we have the tools to make this work for all concerned. Separately the TSG has suggested applying stamp duty to share buybacks and that is something that should be subject to debate.

Certain companies are excluded from participation in KEEP placing them at a disadvantage in attracting staff e.g. this exclusion can exclude certain “FinTech companies” and “InsurTech companies” and should be revisited. Changes were also suggested around employee and share option company limits. Finally, the suggestion was to reduce the tax rate to 10% on the disposal of KEEP shares.

All of the above are valid suggestions and therefore worth considering if KEEP is to do what it aims to do. Budget 2023 is just around the corner so let’s make this happen.

Please note this article first featured in the Business Post on Sunday, 28 August 2022 and was re-published kindly with their permission on our website.

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