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Share and share alike

Having looked at unapproved and approved share option schemes over the past few weeks, including the relatively new Enterprise Management Incentives scheme, I would like to turn my attention to non-option share schemes.

The main example of these until April 6, 2001 was the approved profit-sharing scheme.

Profit-sharing schemes have been permitted since 1978. However, following the introduction of the all-employee share ownership plan, no new schemes have received Inland Revenue approval since April 5, 2001, unless the application with full details was received on or before that date.

The idea on which profit-sharing schemes are founded is that the company makes cash payments to a trust which acquires shares in the company. Trustees hold the shares on behalf of employees who participate in the scheme and the shares are released after certain minimum periods. This is a share incentive scheme rather than share option scheme.

The main conditions to be satisfied to gain approval are:

The scheme must be open, broadly speaking, to all qualifying directors and employees, who must be eligible to participate on similar terms.

The trustees of the scheme must be UK-resident and must use the funds contributed to the scheme by the company to acquire shares. The amount given to the trustees will, as the name of the scheme implies, be determined by the company&#39s profitability in the year. There is no obligation on the company to make a contribution every year. The trustees can either acquire the shares from the employer or acquire them in the market.

There are limits on the benefits that can be secured under the scheme. The maximum market value of the shares which can be appropriated to a member in a tax year is the greater of £3,000 and 10 per cent of the member&#39s annual salary, excluding benefits and after deducing pension contributions, subject to a maximum of £8,000.

There are also strict rules on the operation of the scheme. Having acquired the shares on behalf of a member, the trustees must hold on to them for a retention period of two years. Even after this period has expired, a tax charge will only be avoided if the trustees do not distribute the shares to the member for a further year, that is, three years from the date the shares were first acquired by the trustees for a member and appropriated to him or her under the scheme.

These limits were harsher before April 29, 1996 when a tax charge would arise if the shares were released before the fifth anniversary of the appropriation of the shares.

No tax charge arises on the payment (in effect, a distribution of profit) from the employer company to the trustees. The amount paid is a deductible expense for the company under section 85 ICTA 1988.

Similarly, no tax charge arises when the trustees acquire the shares and appropriate them to the member under the conditions of the scheme and no tax charge arises at the end of the two-year retention period on shares held in the trust.

During the third year following appropriation of the shares to the member, the trustees can distribute the shares to the member but, if release takes place within this year, an income tax charge can arise equal to 100 per cent of the market value of the shares at appropriation or the market value at distribution if less.

The exception to this, in the third year, is where the shares are distributed as a result of the member leaving employment through injury, disability, redundancy or reaching an age between 60 and 75 specified by the scheme. In these circumstances only 50 per cent of the appropriate value of the shares will be charged to income tax.

Once the three-year period has expired, distribution of the shares to the member will not trigger a tax charge.

On subsequent sale by the employee, his base cost for the purposes of calculating any capital gain is the value of the shares at the date the shares were appropriated to the employee by the trustees.

The all-employee share ownership plan is designed to be more flexible than the approved profit-sharing scheme which it has replaced. As mentioned earlier, it has not been possible to commence a new profit-sharing scheme if the application was not received before April 6, 2001. To ensure an appropriation of shares in an approved profit-sharing scheme is exempt from income tax, the appropriation must be made by December 31, 2002.

The all-employee share ownership plan has features resembling approved profit-sharing and savings-related share option schemes. It provides:

For shares, known as free shares, to be appropriated to employees.

For shares, known as partnership shares, to be acquired by employees out of amounts deducted from their salaries.

For the company to provide for shares, known as matching shares, in proportion to any partnership shares acquired by the employee.

The scheme must be approved by the Revenue and meet the requirements in schedule 8 of the Finance Act 2000.

All employees subject to income tax under Schedule E who meet the requirements for eligibility must be invited to join. They must participate on the same terms but free shares may be awarded by reference to remuneration, length of service and hours worked. The plan must exclude those who have, or have had within the last year, a material interest in a close company whose shares may be awarded under the plan or a company that has control of such a company. A material interest is the ability to control more than 25 per cent of the ordinary share capital so the scheme is not suitable for most substantial owner/directors.

An employee must not participate in an award of free shares in a tax year if, in that year, shares are appropriated to him under an approved profit-sharing scheme or he participates in another all-employee share ownership plan.

Next week, I will look at the scheme in more detail.

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