Legislative changes impacting on share plans

A number of legislative and accounting changes have impacted on share plans, says Sarah Coles

Keeping on top of changes to the share scheme market is no easy task. In recent years, employers have had to contend with seemingly-endless legislative changes, many of which, at times, are perceived as having been designed to potentially have a damaging effect on schemes, particularly sharesave plans. From new accounting rules, to age discrimination legislation, and changes to capital gains tax, there has been a potential sting in the tail for share plans every time.

The latest is the rise in the flat rate for capital gains tax (CGT) from 10% to 18% from April next year, contained in this year’s pre-Budget report, delivered by Chancellor Alastair Darling last month. It potentially increases the charges incurred by staff in a sharesave scheme – albeit as an unintended consequence.

Currently, individuals who have participated in a sharesave scheme for more than two years could be paying CGT of up to 10%. The rise, therefore, will see basic-rate tax payers being liable for 13% more, and those in the higher tax bands paying 8% more. Sips, however, are protected from CGT, so staff participating in this type of scheme will not be affected by the change.

Sharesave plans have been under attack ever since share incentive plans (Sips) were introduced in 2000. David Kilmartin, head of share plans at Capita Share Plan Services, explains: “The theory was that Sips would effectively dominate the market to the detriment of sharesave.”

However, in the event, companies were not swift to close their existing schemes. Kilmartin says many simply took advantage of the opportunity to run two different plans, offering both a Sip and a sharesave. The Home Retail Group, for example, launched a Sip when it first came to market to encourage employees to become engaged with the new parent company. It then launched a sharesave scheme a few months later, as the risk-free nature of this plan appealed to risk-averse employees. Similarly, Tesco runs the two schemes side-by-side, and says they appeal to employees for different reasons.

Seven years on, sharesave continues to thrive, and the government seems no nearer to closing the benefit down. In fact, bonus rates on the savings part of the scheme have now been linked to market rates, which, in turn, reflect interest rates. This means bonuses are altered annually to compete with basic rate changes, guaranteeing that the scheme remains attractive.

In September this year, for example, the rates were changed to reflect the Bank of England’s rises in the previous 12 months, with the rate on a three-year scheme rising from 3.19% to 4.23%, while those for a five-year scheme rose from 3.46% to 4.48%. Mark Ife, a senior associate of the employment division at law firm Herbert Smith, says: “It’s unlikely to change a company’s view of sharesave, and we wouldn’t expect new schemes to be implemented on the back of it, but it’s a useful additional savings arrangement.”

Option-based schemes, such as sharesave and company share option plans (Csops), faced perhaps their biggest threat back in 2004 when new accounting standards were introduced. These required companies to reflect the cost of any options they granted in their profit and loss accounts, which, it was predicted, would decimate such schemes, as companies sought to eradicate the liabilities from their balance sheet.

In the short term, companies were certainly wary. Fiona Downes, head of employee share ownership at ifs Proshare, explains: “Some companies initially implemented Sips instead of new sharesave schemes, because these are based on share purchases rather than options.”

Share purchase plans have increased in popularity, particularly for executive schemes. “Over the last few years, there has been a trend among executive schemes away from options, and towards long-term incentive plans (L-tips) – a number of shares granted to senior executives based on performance,” says Downes.

Three years on, however, it appears the sharesave market has weathered the storm, as companies have got to grips with the rules says Ife. “Companies have accepted accounting changes and are dealing with them. People have developed option-pricing models to properly assess the cost and are biting the bullet. It’s not as big a deal as people thought it would be,” he adds.

Instead of cancelling option schemes, some companies have adapted them to reduce their costs, says Kilmartin. “Some companies have made sharesave less attractive, for example, they may have offered it for five years in the past but now they have reduced the offer to just three years, or they may have reduced the discount from 20% to 10%, so it has less impact on the profit and loss accounts.”

There were also concerns that all option-based schemes might be further affected by changes to the Prospectus and Listing rules in August. Initial readings of the rules seemed to indicate that any ‘insiders’ may be banned from buying and selling their options during prohibited periods, for example, in the run up to the announcement of results and other periods when the company is privy to price sensitive information. The vague wording of ‘insiders’ led to concerns that any employee may face restrictions on the operation of their sharesave scheme. However, Ife points out: “The Financial Services Authority (FSA) explained that ‘insiders’ really meant those discharging managerial responsibilities. It also clarified that all-employee share plans are still excluded from the code. People haven’t picked this up as very important, but it’s good that all-employee schemes haven’t been affected.”

Age discrimination
Share schemes have also been indirectly affected by other pieces of legislation, such as last year’s age discrimination laws. Within share plans, it is a big deal whether someone is considered to be a good or a bad leaver. A good leaver in a Sip, for example, will retain their tax benefits even if they haven’t been in the scheme long enough to qualify for them. A bad leaver, meanwhile, will be forced to pay the tax back.

In the past, it was easy to identify good leavers as anyone who was made redundant or hit retirement age was considered to be so. But the question remains about how employers can identify a retiree when they have no retirement age. “Companies are having to look at their definition of retirement, whether they have a retirement age, or whether they define retirement as leaving work altogether as opposed to working for the competition, and how do you police that if someone retires and then goes back in to some form of work? It’s a minefield,” explains Ife.

It is still too early to fully assess the impact of the age discrimination legislation, although Ife believes that, as long as a company considers it carefully and drafts its rules accordingly, it shouldn’t damage schemes.

So it seems legislation has so far failed to derail share schemes. “In fact, we have seen an upsurge in sharesave ourselves, securing 17 plans in the last year,” says Kilmartin.

But while schemes will weather legislative storms, employees will be highly reluctant to buy into a falling market. “When share prices are down, arguably it can be the best time to get into a share plan. But people have tended in general to think ‘share prices are falling I’d better stop investing’,” Kilmartin adds.

This can hurt the take-up of all-employee schemes, and for executives, it can damage the effectiveness of option schemes. “Option scheme participants are saying ‘we might be hitting our performance targets but if the market moves and we have no control over it our options become worthless’,” explains Ife.

Schemes rely, to a certain extent, on markets showing some signs of strength. It’s, therefore, not surprising in the past four years of share price growth, schemes have thrived despite legislative changes. However, it is not clear what will happen if the government continues its assault on schemes and the financial markets start to struggle.†

Case Study: BHP Billiton

Global shares at BHP Billiton
The scheme, which offers a free share for every share purchased as long as the stock is held for three years, has so far achieved a 30% take up. When launching the plan, the mining company wanted a scheme that would encourage staff engagement and align employees’ interests with those of shareholders.

Geraldine Pamphlett, share plans manager, explains that the aim was to “recruit, develop and retain talented and motivated employees who share our vision and values”.

That is why it opted for a plan that requires employees to commit their own money. It also wanted a common global offering. Pamphlett says it’s unusual to introduce “a single uniform plan, with neutral tax implications, and to offer identical terms across so many jurisdictions and to so many employees.” This was the only way to ensure that every employee had the same rights.

The scheme was devised by PricewaterhouseCoopers and Computershare.