Background

Death and taxes are our only certainties. Yet we endeavour, nonetheless.

Within our struggle, share ownership is on the rise and is now part of our vanilla economic life, both for the executive top talent and broad-based employees. Another phenomenon was the swift rise of salary sacrifice plans in recent times. The aim was to exchange salary for a similar value lower taxed benefit. But unsurprisingly, since 2017 HMRC taxes people on the highest value, the benefit received, or the cash forgone by a sacrifice arrangement. A few exemptions apply for pension contribution/advice, cycle schemes, low emission vehicles and employer supported childcare. Employer shares are not on the list.

Employee Share Benefits

Employee shares plans are not shortchanged, however. Instead, tax favoured plans apply including CSOP, EMI, Sharesave and SIP. But still, and outside the tax-favoured SIP, any arrangement sacrificing salary to obtain employer shares may be taxed upfront in full.

However, to trigger this tax outcome, a contractual arrangement to swap salary for something else is needed. Where that is not the case the tax rules do not bite.

For example, when an employer can use discretion over value to be paid to an employee, which can be delivered in shares on a tax favoured basis. Discretionary payments, bonus or otherwise, are a key focus here.

At the outset of the pandemic, some companies suffering a material diminution in their cash income stream but keen to retain key staff, did enter into bespoke arrangements for salaries to be reduced or sacrificed. Separately, individuals were granted incentives in the form of share awards, which were not taxable upfront, but only on the future delivery of the shares, which was typically conditional on a number of factors.

This is slightly different – salary was not swapped for anything; it was merely sacrificed. The relevant individuals were separately incentivised to remain in the business through a share award.

Employee Shareholding Requirements

The requirements for employees to obtain shares in the UK are:

• Executive Share Ownership Guidelines or “SOGs” for directors of listed companies.
• Annual bonus deferred into shares, mainly top earners; and
• Financial Services bonus investment in shares or instruments rules.

A typical Share Ownership requirement is for a director to acquire shares worth two times base salary over a five-year ramp-up period. This equals buying shares worth 40 percent of salary each year. SOGs do not typically specify the run rate of acquisition, nor the sources of money used to buy the shares. The general intent of institutional investors is that these should increase as incentive pay gets bigger. Bonus deferral into shares is also commonly seen. For listed company directors and material risk takers in financial services among others.

Tax Efficient Structuring of SOGs and Bonus Deferred into Shares

SOGs and share bonus deferral unfold in the UK using various mechanics. For high earners annual bonus payments can be significant. Typically, bonus is discretionary and so a pause-step to consider equity delivery is appropriate. Deferred bonus into shares is often delivered as ZEPOs (Zero Exercise Price Options), which have no exercise price and so in economic terms are free shares. But these are income taxed in full on exercise. No CGT treatment applies because shares were not held over the option’s life. That happened only from the point of exercise onward.

But this is not a bad outcome. Extra income tax (i.e., over and above what would have been paid had the bonus value been paid out in cash) applies only if there is a rise in share price. If instead the shares go down, the tax is less. So, there is a tax shield for the first part of the share price loss. And using ZEPOs rather than - for example – restricted stock units, can give individuals a degree of choice as to when the tax charge is triggered as they can choose when to exercise the option. This can help an individual who is perhaps moving into a lower tax bracket (e.g., on retirement or moving to a part-time role).

• Step one is for companies to review the bonus deferral mechanics and ensure this operates tax smoothly.
• Step two is for companies to reframe the basic delivery mechanic, maybe tweaked to deliver CGT for share price gains. It is possible to deliver deferred bonus shares as upfront restricted shares and make any appropriate tax elections to pay income tax on the full value of the shares at the point of delivery. This ensures that any future share price gain during the deferral period will fall within the CGT regime, at a potentially lower rate. (Alternative structuring involving a CSOP or JSOP may also be something for companies to consider in the right context – both potentially for deferred bonus and also for long-term incentives but is not aligned with current market practice in the listed environment, given the additional complexity and noting that costs, including dilution costs, will typically be higher).

Tax structuring top executive pay for listed companies is objectionable generally, but in this case the greater good is served. It allows executive share investment to unfold unfettered by side-bar tax concerns.

Until recently, proxy advisors and institutional investors siloed consideration of share exposure rules. Equity in LTIP, equity SOGs and equity bonus deferral were each distinct for box tick purposes.

The Investment Association PoR 2025 helpfully conjoined thinking on SOGs and bonus deferral. The aim overall is for executives to have strong alignment interest with shareholders. The focus instead is on whether shares have vested and/or are subject to further performance conditions.

Yet these arrangements need to be viewed from their economic fundamentals. All should count for compliance purposes.

This Investment Association insightful approach should extend fully to all those who govern the equity rules and their delivery mechanics.

All companies should review their equity delivery mechanics to ensure tax leakage does not dim the incentive impact of their share incentives.

While death and tax are inevitable, the future remains bright.