The recession has thrown share schemes into confusion, and employers and employees are having to reassess their options, says Nicola Sullivan

Focus on facts:

What are employee share plans?

In a sharesave plan, employees can save a maximum of £250 a month over a period of three, five or seven years. At the end of the period, they are able to buy shares at a price fixed when the scheme began. Alternatively, if their company's share price has fallen in the interim, employees can withdraw their cash at maturity and still earn a savings bonus.

Through a share incentive plan (Sip), an employee can purchase shares worth up to £1,500 a year tax-efficiently. These must be held for at least three years, and for five years in order to be tax-free. Employers can add to share purchases with a matching number of shares, giving the employee £3,000 worth of free shares.

What are the origins of share plans?

Employee share schemes' roots can be traced back to the late 1880s, when a pamphlet entitled On profit sharing between labour and capital: a word to working men was published. Sharesave schemes first emerged in the early 1990s, and Sips were introduced in the Finance Act 2000.

Where can employers get more information?

The HM Revenue and Customs website contains information about plans (www. hmrc.gov.uk/shareschemes). Industry body Ifs Proshare (www.ifsproshare.org) and Business Link (www.businesslink. gov.uk) also provide useful information.

In practice:

What are the costs involved?

Costs vary greatly from business to business, but, typically, administrators will charge between £8,000 and £20,000 to set up a sharesave scheme.

What are the legal implications?

Businesses are required to set rules on eligibility, outlining what happens if staff leave the company. Usually, if an employee leaves, the option can no longer be exercised unless they leave because of special circumstances. They can either carry on saving and take the cash and bonus at the end of the savings period, or close the account and take the payments made, together with any accrued interest. It must also be made clear to staff that share plan provision is not automatic, and is independent of employment contracts.

What are the tax issues?

With sharesave schemes, employers must gain approval to offer staff a discount of up to 20% on the market price. If the scheme complies, staff are not liable for tax or NI on the gains they make from the options, and employers will not have to pay corporation tax in relation to the plan. If staff make a profit when they sell the shares, they will probably have to pay capital gains tax on gains above their allowance. Shares in a Sip are tax-free if shares are held in trust for five years. Shares can be traded after three years, but will not attract the full tax relief.

Nuts and bolts:

What is the annual spend on employee share schemes?

According to HM Revenue and Customs, in 2008 about 940 approved sharesave schemes were in operation, costing the government £520 million in tax and NIC relief. Meanwhile, HMRC reported there were 960 Sips in place in 2008, costing the government £300 million in tax relief.

Which employee share scheme providers have the biggest market share?

Some of the biggest players include Capita Share Plan Services, Computershare, Equiniti, HBOS Employee Equity Solutions, Killik Employee Share Services, Royal Bank of Canada, The Share Centre and Yorkshire Building Society.

Which employee share scheme providers have increased their market share?

No official figures are available, but Yorkshire Building Society and HBOS Employee Equity Solutions have both grown through acquisition.

MAIN†ARTICLE

Employee share schemes have always been at the mercy of legislation and market movements - and never more so than now. Plummeting share prices and interest rates have caused problems for sharesave schemes, while cost pressures have forced employers to review whether to offer all-employee share plans at all. Only executive schemes are benefiting from this environment, being considered a more tax-efficient and politically-acceptable alternative to bonuses.

Sharesave or save-as-you-earn (SAYE) schemes have been under pressure from various sources. Market turmoil and falls in share prices have taken their toll on these schemes, with the option price now often much higher than the current share price, so staff cannot benefit from the scheme. Sue Bartlett, senior consultant in executive pay and compensation at Watson Wyatt, says: "Sharesave plans are underwater, so people are not taking the shares. There is a bit of a bunker mentality at the moment."

Falls in the Bank of England base rate have created an anomaly in the bank accounts behind sharesave plans. These cannot keep pace with interest rate drops, so often the bonus rates offered within plans are higher than those available on a normal bank account. This means some administrators have begun to charge for setting plans up for employers in order to get money back. Which, in turn, means schemes have become more expensive for employers.

Chancellor Alistair Darling's last Budget included a measure intended to relieve this problem. The change, which will come into effect in the Finance Bill 2009, slashes the time period in which interest rate changes take effect. Louise Drake, national sales manager at Yorkshire Building Society, says: "The rate applicable to sharesave accounts will be more in line with what is happening to savings rates in general." This should make extra administrative charges less common.

But at the moment, the combination of higher costs and lower benefits means sharesave - always a firm favourite with employers and staff - is beginning to be overshadowed by share incentive plans (Sips). The Ifs Proshare Annual Employee Share Plan Survey, published in May, shows the number of live sharesave plans offered by its members dropped from 683 in 2007 to 667 in 2008. While the number of members offering a Sip increased from 389 in 2007 to 459 in 2008. Deborah Broom, senior business development manager at Capita Share Plan Services, adds: "The big difference this year is that the new plans coming to Capita are much more likely to be Sips, whereas last year we had lots of sharesaves being set up."

Sips allow employees to buy shares immediately, rather than offering an option to buy at a later date. This means the employees carry the risk if the share price falls. However Sips could also be seen as an opportunity to buy more shares in a depressed market. Broom says: "While shares are at the cheaper price, it is potentially a better time to buy."

The price also offers a tax break for staff. Shares are completely tax-free if they are held in trust for five years. If they are traded after three years, it will not attract the full tax relief. Julie Richardson, head of employee share ownership at Ifs Proshare, explains: "Between three and five years, you pay tax and national insurance contributions based on the lower market value or their price at the award date. It is kind of a tax break at that stage."

So if the award price was very depressed, the tax will be low, too. Sips therefore have their attractions for staff, but remain under threat in the current market. Martin Osborne-Shaw, managing director at Killik Employee Share Services, says he has seen an increase in the number of employers opening up exclusive plans for their executives rather than all-employee plans. "Companies always look after their executives if money gets tight," he says. "Staff are, unfortunately, the ones to suffer. We have had a few employers wanting to withdraw their all-employee plans purely on a cost basis, either in terms of administration or because they are funding the share plans from their own means."

In the executive reward market, new tax rules are favouring company share option plans (Csops). Watson Wyatt's Bartlett says these will receive a boost when the Budget's tax hike to 50% for people earning more than £150,000 comes into effect. This is because, like sharesave plans, the profit made at the end of the plan is taxed as a gain rather than an income. "Gains are taxed at only 18% and only then once the employee has exceeded their annual capital gains tax exemption, whereas a gain from an unapproved share option plan is taxed as income and subject to national insurance as well," says Bartlett.

Another advantage of Csops is that, unlike Sips and sharesave schemes, they do not have to be made available to all employees. As a faltering economy forces companies to be more strategic and selective with reward, Csops become more central to strategy.

Executive schemes are also considered a more palatable alternative to short-term bonuses in the current environment. Bartlett says: "A lot of companies like to be able to give options as a motivator and an incentive, as well as a reward for good performance."

Many companies are currently looking for ways to tweak their share schemes to make them more appealing and motivating for employees. "Some advisers have said they are looking to put in plans that partially vest immediately, so the executives can see some value straight away," says Capita's Broom. "But employees might have to go through some sort of performance condition before the shares are awarded to them. It is about fine-tuning rather than coming up with anything new."

The appeal of share schemes will always depend on the market to a certain extent. Contrary to the prevailing mood of the past two years, late spring saw shares stage something of a recovery, which was felt by employee schemes. Sharesave plans that were open during the rally saw take-up improve quickly, and it is a good time to launch a scheme. But Drake warns: "If employers are tempted to make an offer because share prices are attractive, they should consider what impact this may have on older grants and whether employees will be tempted to pull out of an old offer to go into a new one purely on the basis of a lower option price."

If we are in the early stages of a market recovery, share plans may be about to have a new lease of life. But employers should not rely entirely on the market to deliver their objectives. To attract maximum take-up, effective financial education is essential to restore employee confidence in the benefit, as well as ensure staff are aware of the different ways they can invest future gains in a tax-efficient way.