With equity markets continuing to perform strongly, share options have become an increasingly important part of an employee's remuneration package - particularly for those working for publicly listed companies.
Now however, the Revenue is stepping up its oversight of how and when options are being administered and taxed.
So what do you need to know?
Revenue’s move
As Thalia O'Toole, a tax director in KPMG notes, there is now "almost an expectation", at least in certain sectors, that share remuneration will feature as part of an employee's overall package.
And in line with this increasing provision of share-based pay, Revenue has stepped up its oversight of the area.
Last year’s Finance Act provided for the mandatory electronic reporting of certain share-based remuneration, not already covered in existing returns. That includes restricted stock units for the first time, through the Form ESA. The aim of this is to give the Revenue a better understanding of share-based remuneration.
The original 2020 due date for employers to file the form was August 31st, but Revenue has now extended this to September 14th.
Revenue may look to cross-check the information provided by the employer to ensure that capital gains and dividends are reported by the employee. So employees need to ensure that their tax obligations are in place.
However, this isn't always the case. A survey from taxback.com earlier this year found that most employees are in the dark about the potential tax liability they may face on shares they receive from their employer or options to buy shares.
The challenge can arise because it is sometimes up to your employer to account for any taxes you owe, and sometimes it is up to the employee.
“Often employees forget to file a tax return,” says O’Toole.
So what are the requirements for the various option regimes?
How are share options taxed?
As Michael Rooney, a tax partner with EY notes, in general, share options will be taxed as employment income. "It's similar to getting a cash bonus, as you'll pay income tax, USC and PRSI on it," he says. In short then, you could be looking at a potential top tax rate of 52 per cent.
Generally, the taxable element of a share option will be the difference between the price the employee has paid for the share, and the price they’re worth when exercised.
What tax applies to a share option will often depend on when an employee takes ownership of the underlying shares. After all, an option is a right given to an employee to buy a share in a company, at some time in the future, at a price fixed on the day the option is granted.
“When you look at share options, it’s a right to purchase shares at some point in the future at a fixed price,” says Rooney.
If the share price has risen at that point in the future, then the employee may look to exercise that option; if it has fallen however, then the option may end up being discarded.
Capital gains tax (CGT) applies to any gains between the exercise of such an option and sale of the underlying shares, at a rate of 33 per cent, although an annual exemption of €1,270 per individual will typically apply. If you exercise your option and sell on the same date, CGT won’t apply, as there will be no gain.
With an unapproved share option, you must pay tax owed and file an RTSO1 form within 30 days of exercising the option. In addition, you must also file an income tax return for the relevant year.
However, a number of specially approved schemes are also possibilities, some of which may be more tax efficient. “Employers would normally have one to two share arrangements in place,” says O’Toole.
Restricted stock units
One option is a so-called restricted stock unit which, according to Rooney, has become increasingly popular, as it offers a value to employees, regardless of share prices.
This is because with a restricted stock unit, you can exchange your option for cash – or shares – once the vesting period has passed.
Consider an option to purchase shares at €50 in three years’ time. If they are then worth €100, you might be inclined to exercise the option. If the share price has fallen to €40 however, as Rooney notes you won’t want to pay €50.
But with a restricted stock unit, you can take the cash value of the options.
Once the units are vested, income tax, PRSI and USC will be deducted through payroll, with CGT applying to any subsequent gains.
Save as your earn
The Revenue has approved a number of savings-related share option schemes (SAYE), which allow employers offer share options to their employees in a tax efficient manner.
The scheme allows an employee to save a fixed amount – between €12 and €500 a month – over an agreed period of either three, five or seven years. The employees are then granted options based on the amount they have saved, and they can use their savings to exercise some or all of these options. Alternatively, they can opt to just take their savings in cash.
“It offers a real incentive for employees to invest in the company they’re working in,” says Rooney.
For an employee, the benefit of this approach is that they will have cash to hand to exercise their options. They can also avoid income tax when they exercise the options, as only USC and PRSI apply. In addition, no DIRT applies on interest earned during the savings period (not that much would apply at the moment).
“The income tax saving could be quite significant depending on how high the market value of the share has gone and depending on the price you’ve paid,” says O’Toole, adding that the downside is that it is “quite a long commitment” in terms of the time spent saving.
And CGT will apply to any gain when shares are disposed of.
From a reporting perspective, employees must disclose information on exercising the option in an annual income tax return.
Approved profit-sharing scheme
Again this scheme must be approved by Revenue but, as with a SAYE, there may be tax savings with an approved profit-sharing scheme.
Under this arrangement, shares are allocated to an employee but are held in trust for a fixed period of time, which is typically at least two years. When the employee is allocated the shares, USC and PRSI will apply, and will be paid via PAYE system. However, if the employee holds the shares for three years then they may be sold free of income tax, although CGT will apply to the gains.
There are limitations. As O’Toole notes, a “significant” number of conditions have to be met in order to offer an approved profit-sharing scheme. These include that the scheme must be open to all eligible employees, while employees can only get shares up to a maximum annual value of €12,700.
If held for three years or more, taxes are the responsibility of the employer to pay. However, where the shares are sold before the three-year deadline, they become liable to income tax and that is a matter for the employee.
When it comes to reporting, employees must file an annual tax return noting the acquisition of shares and subsequent disposal.
KEEP
Introduced in the 2017 Finance Act, the Key Employee Engagement Programme (KEEP) is a scheme introduced specifically to accommodate certain qualifying SME companies for their employees or directors. Unlike with traditional share option schemes, no tax – income, USC or PRSI – applies when the share options are exercised. The only tax issue is CGT on disposal.
“The capital gain is on the market value of shares less any price you paid to exercise,” says O’Toole, adding that, with KEEP, the employer is “effectively providing a potential 19 per cent saving for employees”.
However, she adds that the attractiveness of the scheme is “outweighed by some of the conditions that are in place to make them qualifying share options”. Among these are the exclusion of certain companies, such as financial institutions and professional services firms, from offering these shares.
“It started off quite slowly, as the conditions are quite onerous, but it is starting to gain in popularity,” says Rooney.
From a tax reporting perspective, once exercised employees must file and pay any CGT owed, and must also file an annual tax return.
What’s in it for employers?
For employers, there may be an incentive to offer share options as part of an employee’s remuneration package over traditional salary/cash bonus. This is because employer’s PRSI, currently levied at a rate of 11.05 per cent, doesn’t apply when offering remuneration via shares.
