Employee shares find ready takers

EMPLOYEE share ownership commands a degree of cross- party political support normally reserved only for matters of deepest crisis.

To the Conservatives, employee share ownership is popular capitalism at its best; to the Labour Party, it represents a step towards worker control; and to the Liberal Democrats, it is a living example of social co-ownership. They invented the whole thing anyway, with the profit-sharing scheme introduced by the Lib-Lab pact back in 1978.

As a result, many companies are keen to promote employee share ownership not just for key executives but throughout the workforce. But the question remains as to the best means of achieving that objective.

Share options are immensely popular with employees, as they offer a risk-free opportunity to achieve substantial reward.

If the share price increases the employee stands to gain. But if the share price falls, the employee does not share the pain.

An alternative arrangement is to pay an annual bonus by way of shares through an Inland Revenue-approved profit-sharing share scheme. Under these schemes employees can receive shares with a value of up to 10 per cent of their salary (subject to a maximum of pounds 8,000) completely tax-free provided they retain them for five years.

Employees earning below pounds 30,OOO may receive shares with a value of up to pounds 3,000 even though the value of the free shares exceeds the 10 per cent of salary limit.

Employees cannot sell the shares for the first two years and will trigger an income tax charge if they sell during the following three years.

The shares only become income tax-free after they have been held for a minimum of five years - although special rules do apply in cases of injury, disability, retirement, redundancy and death.

Marks & Spencer has operated a profit-sharing scheme since 1978, when they were launched. Last year it put aside pounds 18.1m in shares under its scheme for 43,000 of its 52,000 employees. It was standard practice in all the recent privatisations for a free and a matching scheme to be offered to employees.

The aim of the legislation is clear - to encourage employees to become active shareholders in the long term.

Employees who receive shares under a profit-sharing scheme tend to keep them for a long time, which may be much more effective at creating real employee share ownership than option schemes. Under most option schemes, employees tend to sell the shares as soon as they have exercised their option.

Some companies are reluctant to pay a bonus by way of a profit-sharing share scheme because the overwhelming majority of employees tend to opt for cash whenever a choice of cash or shares is offered.

Profit-sharing share schemes are often seen as a poor relation to a registered profit-related pay (PRP) scheme. Under a PRP scheme, all employees can receive 20 per cent of pay, up to pounds 4,000, free of tax.

Tax-free cash is also likely to be far more attractive to employees than tax-free shares deferred for five years.

However, PRP and profit sharing schemes are not mutually exclusive and, increasingly, companies are exploring both.

The possibility of paying staff large proportions of pay completely tax-free and, in the case of a profit sharing scheme, free of National Insurance, should not be ignored as the table illustrates.

Possibly the most innovative use of the profit-sharing scheme is the splendidly entitled BOGOF scheme. BOGOF stands for Buy One, Get One Free and is sometimes more elegantly referred to as a matching offer scheme.

A well tried and tested retailing concept, Buy One, Get One Free is attractive to employers who want to encourage their employees to buy shares in the company, albeit on favourable terms.

By establishing the scheme on a Buy One, Get One Free basis, employers ensure that their employees have the opportunity to buy shares at a discounted price whilst also creating a structure that establishes real employee shareholding rather than mere option holders.

More sophisticated companies will further encourage employee investment under a BOGOF scheme by persuading employees to save by way of deduction from payroll.

They will also ensure that dividends and capital gains are both tax free by establishing a corporate PEP through which the employees can invest.

Brian Friedman is a partner in the Employee Benefits Practice at Arthur Andersen.

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