Buyer’s Guide: Share incentive plans

Five-year-long results for Sip investors have proved encouraging and there’s even better news to come from pension changes, says Jamin Robertson

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It is the end of term for pioneer share incentive plan (Sip) investors – the celebration of a five-year anniversary, which for many employees has resulted in huge windfalls.

Sips came in to life in 2000 and offer tax and national insurance (NI) breaks to employees providing they hold shares in the plan for up to five years. Gas and electricity company Scottish Power, was one of the first Sip participants and many of its staff, after making contributions of £125 a month, now each hold an investment valued at more than £23,000.

A one-for-one employer-matching deal, share appreciation of 9%, and tax and NI relief offered on shares held for the full term of five years mean the gain came at a net cost to Scottish Power’s basic rate taxpayer employees of just over ¬£5,000.

Sips were created by the Finance Act 2000, and are designed to foster productivity by inviting employees to invest in their organisation. The scheme replaced approved profit sharing schemes, which had existed for 20 years and were perceived to no longer meet the needs of businesses.

According to the Chartered Institute of Personnel and Development’s (CIPD) Reward management survey 2006, 35% of employers now operate a Sip, up 6% on last year.

Sips are typically favoured by 40%-rate taxpayers, as they stand to make the biggest gains from the tax breaks. But the big news for all share scheme investors this year is the changes to pensions legislation due to take effect on 6 April. From this date, maturing shares can be transferred from a Sip into a self-invested personal pension (SIPP). Funds are then grossed up to the relevant tax rate.

According to projections by Sip provider Killik Employee Share Services, Sip investors stand to gain returns of up to 811% for higher rate tax payers in a scheme where shares are matched one-for-one and appreciate by an optimistic 10% per year. Last year’s introduction of the new International Accounting Standard Board rules, which require firms to clearly expense share scheme costs on their profit and loss accounts, has not hampered the modest growth of Sips. Justin Cooper, managing director of Capita Share Services, explains: "Employee share plans are now so embedded in the overall remuneration package that despite the fact that they are now a direct hit on the profit and loss account, companies still consider them valuable enough to retain."

Geoff Price, director of global share plans at Computershare, says it is sharesave schemes have been affected most in recent years. "If the scales were slightly in favour of sharesave in the last few years they might be dead even now."

Providers in the Sip market can be generally grouped into two camps: law firms that advise companies on the formulation of Sips and financial houses that administer them.

William Franklin, senior associate of the share plan team at law firm Pinsent Masons, says that Sips are not all plain sailing for employers. He says some employers have seen major pitfalls. "There are some very nasty tax traps in Sips. One of the problems is the national insurance (NI) relief that the employer saves on the shares the employee buys. Well, that sounds great, except when the employee leaves or has to sell [their] shares because of a takeover within three years. "When that occurs, it triggers a claw back on national insurance.

†The problem for employers is that it is calculated not on what would have been paid originally, but on the current share value, when it is higher." The result for some is an unexpectedly high NI bill. "I’ve seen it happen on a number of occasions. People couldn’t believe the amount of additional NI that was payable." Franklin wants to see legislative changes to Sip conditions to help limit employers’ exposure where staff turnover is an issue. "I can’t see why you can’t simply cap NI at the amount of the original saving. The idea is a good one, but Sips haven’t been as successful as the government hoped," he says.

But Phil Ainsley, senior manager at Lloyds TSB, argues the golden handcuffs discourage employee withdrawal. "Some firms have been worried that the NIC liability is uncapped. For most companies, as long as people remain employed, then they aren’t selling the shares. The drop out rate is about 1%, it’s incredibly small. If the company has some forfeitable matching shares then it does help persuade people not to cash out and leave."

However, industry observers are united in the belief that the holding term for tax relief should be reduced from five to three years. Patrick Brennan, director of corporate services at Barclays Share Plans, says: "We’re getting an increasing amount of churn. Take the US model. It has an employee base of 150m people, and 50m are changing their jobs at least once a year. We’re not at that stage yet, but employer trends are similar."

Capita’s Cooper agrees a three-year term fits the bill. "It’s a frustration. We are all looking for a reduction in the holding period." He adds that the sharesave market got a real boost when the term was reduced to three years, so there is no reason why Sips should not get the same shot in the arm.

In the meantime, employers considering Sips would do well to look for outside help. Only a minority of firms opt to run Sips themselves. Legal and tax minefields mean that most employers call in the experts.

The Facts

What is a share incentive plan (Sip)?
A share incentive plan is an investment vehicle offering tax and national insurance breaks to employees providing they hold shares for five years. Employees may invest up to £1,500 or 10% of their salary (whichever is lower) in partnership shares, which the company may choose to match up to a maximum rate of two-to-one. Firms may also give free shares up to a limit of £3,000. Dividends from shares can be reinvested to a maximum of £1,500 per year.

What are the origins of Sips?
In 1999, Gordon Brown outlined plans for an all-employee share scheme, which was included within the Finance Act 2000. The aim behind the scheme was to promote wider employee ownership in organisations.

Where can employers get more information and advice?
For more information on Sips visit HM Revenue & Customs at Employers can also learn more through not-for-profit advocacy service IFSProshare at The organisation conducts regular training, research and network programmes for employers.

What are the costs involved?
Fees are typically charged on a transactional basis so will depend on employee numbers. Costs may range from £10,000 for a basic plan through to £150,000 for a high-volume plan. Employer tax relief on national insurance contributions can offset ongoing administration costs.

What are the legal implications?
Companies must set up a trust to hold Sip shares and must open the plan to all employees. Shares used in a plan must be in a company listed on a recognised stock exchange or in its subsidiary, or in a firm that isn¬’t controlled by another company.

Nitty Gritty

What are the tax issues?
Employers must obtain HM Revenue & Customs approval to benefit from tax and NICs exemptions. Employees buy partnership shares out of pre-tax salary, thereby reducing the amount of salary on which tax and NICs is paid. If shares are held for five years, they are free from both income tax and capital gains tax (CGT). Shares may be traded after three years but do not attract full tax relief.

A very limited number of employees may find participating in a Sip affects their social security benefits. For employers, there is relief against corporation tax and NI relief on shares gifted to or bought by employees through a Sip.

In Practice

?What is the annual Sip spend?
Because many shares are based in foreign stock markets it is impractical to estimate.

Who has the biggest market share?
Capita Share Services claims to hold a one-third share in the market for outsourced share incentive scheme business. Lloyds TSB Registrars handles the Sip business for 23 of the 69 FTSE firms that have launched a scheme. Ogier Fiduciary Services, Computershare and Barclays Stockbrokers, which reported a 100% growth in its Sip business last year, also administer a number of schemes.

Which Sip provider has increased its market share the most?
Sips have operated since 2000, so many major firms are already on board. Most providers say growth has been steady over the past year, with increased business from switching clients, and among clients¬’ French and US subsidiaries.

Sips have operated since 2000, so many major firms are already on board. Most providers say growth has been steady over the past year, with increased business from switching clients, and among clients¬’ French and US subsidiaries.