For small firms and start-ups without the deep pockets of multinationals and other large competitors in the talent market, share incentive schemes are one way of rewarding and incentivising key employees. But it is far from a straightforward proposition.
If not handled correctly, employees can end up paying full tax, USC and PRSI on the value of shares which they can’t sell because there is no market for them. In effect, they would have to take a hit on their take-home pay in the hope of a financial reward at an unspecified date in the future.
When approached correctly, however, they can be very useful indeed. “Employee share incentive schemes can be a powerful tool for both attraction and retention, particularly for scaling Irish companies competing internationally for top talent,” says EY Ireland tax partner Michael Rooney.
“They allow employers to compensate employees competitively without relying solely on cash, which is especially valuable for Irish SMEs,” he continues. “They encourage longer-term retention of key employees as value is typically realised only on an exit or liquidity event.”
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They also offer employees a chance to share directly in the upside of the business they are helping to build, Rooney adds. “Across the board share incentive plans provide a sense of employee engagement and loyalty that pure salary or bonus structures often fail to achieve. Employees feel like key stakeholders as they are shareholders of the business.”
The Government recognised the potential of such schemes and introduced the Key Employee Engagement Programme (KEEP) in 2018 to put a structure around them for SMEs. “It lets qualifying Irish SMEs reward key staff with share options in a tax efficient way,” explains Camilla Cullinane, EMA head of family business and tax partner, KPMG. “Where certain conditions are met by the company, employee and option, such as the company being an unquoted SME and the options being issued at market value, then no income tax, USC or PRSI arises on grant or exercise of the shares. Instead, capital gains tax (CGT) is paid when the employee ultimately sells the shares.”
So far so good. What’s not to like about a scheme that offers such a significant tax advantage? As usual in such matters, the devil is in the detail, and the scheme has been criticised for its quite rigid and burdensome rules and punitive penalties for even minor cases of noncompliance.
“A major obstacle with KEEP is the challenge of valuing company shares at the time share options are granted,” says KPMG tax partner Olivia Lynch. “Large companies can engage professional valuers and often benefit from established markets, but SMEs and start-ups typically lack both the resources and market access. The absence of clear guidance from Revenue on share valuation further complicates matters. If Revenue later determines shares were undervalued, the KEEP benefits may be withdrawn, leaving employees liable for higher taxes despite acting in good faith.”
The criticism of the scheme is valid, according to Marie Flynn, private client tax director and head of management incentivisation with PwC Ireland, who says she hears it “time and time again from SMEs who wish to implement such a scheme.”
The rules are disproportionately burdensome for smaller SMEs, she points out. “Valuation requirements are complex and costly for SMEs. For pre-revenue or loss-making companies, determining market value often requires professional valuations – an expense many small companies cannot bear. Medium-sized firms often have access to advisers who can navigate valuation, filings, and compliance but early stage, resource-constrained companies struggle.”
The late filing rule is exceptionally harsh, she adds. “A single missed KEEP1 return automatically disqualifies a company for that year, turning all employee options into unapproved options. This can create catastrophic outcomes: employees unexpectedly face income tax, USC, and PRSI of up to 52.2 per cent, and employers bear payroll liabilities/risks from 2024 onwards.”
ISME chief executive Neil McDonnell agrees: “If an employee is lucky enough to work for a quoted company offering a scheme, that’s great. The valuation is the share price on the day. That is not the case for the 99.8 per cent of companies in the country that aren’t quoted. They have written a rule for the 99.8 per cent, based on what happens for the 0.2 per cent.”
He points to the hypothetical case of a business with a number of trusted high-performing managers whom the owner wants to keep in place by rewarding them with share options. “If it has €10 million in sales and you put a value of €5 million on it when giving those managers a bit of equity that’s fine,” he notes. “But if a private equity firm comes along later with a higher valuation that can trigger a major tax headache for those managers.”
Flynn suggests some improvements which could be made to make the scheme more attractive. These include a penalty-based system for late filing, rather than full disqualification. “This single change would remove the biggest pitfall for SMEs,” she says.
Another important change would be the introduction of safe harbour valuation rules which could use a funding round within the last 12–18 months, apply permitted minority discounts, or adopt prescribed valuation methodologies as their basis. “This would reduce cost and remove uncertainty. In addition, it would be useful for the provisions to include a rule whereby if the valuation used were determined to be incorrect that, rather than the scheme ceasing to qualify, there would be an income tax charge on the undervalue at the time of exercise.”
There are alternatives to KEEP, of course. According to Rooney, the most common are unapproved share options, growth or flowering shares and restricted share awards (RSAs).
Unapproved share options offer an employee an option to acquire shares at a predetermined price, he explains. Their value increases if the company’s valuation increases over time. “Unlike KEEP options there is no preferential tax advantage with regular share options as these share option gains are subject to PAYE, USC and employee PRSI.”
Growth shares allow employees of private companies to participate in the future growth of the company. “Typically, growth shares are awarded to employees based on them having nominal value as their value is intrinsically based on ‘hope’ value tied to future growth or success,” says Rooney. “However, it is important for companies to be comfortable with the valuation of the shares. The main benefit of growth shares is that modest or nominal income tax liabilities can arise for the employee at grant of the award with the uplift in the value subject to CGT.”
Restricted share awards allow companies to award shares to employees with a restriction on their disposal and favourable tax relief. “Where the shares are held for over five years, a 60 per cent reduction on the taxable income can be granted,” Rooney points out. However, while the potential tax saving is attractive, he says, “There is still an upfront tax charge for the employee at grant, without any liquidity in the shares to cover the tax bill.”
Given the broad consensus on the importance of such schemes, there is a strong case for measures to increase their uptake. “It is crucial to simplify and modernise existing schemes if Ireland is to effectively increase the uptake of employee share incentive schemes, particularly among SMEs and private companies,” says Lynch.
“Reforming the Approved Profit Sharing Scheme (APSS) and Save As You Earn (SAYE) would involve removing the requirement to offer schemes on ‘similar terms’ to all employees, which has been a significant barrier for SMEs. Additionally, abolishing the preapproval requirement and transitioning to a self-certification model would streamline processes. Broadening schemes to allow for other forms of shares other than just ordinary shares, would offer more flexibility. Raising savings and investment limits for SAYE and APSS could also drive wider participation.”
Rooney calls for simplification and greater clarity. “In EY’s work with scaling Irish businesses especially through our EY Entrepreneur of the Year programme, we increasingly hear from clients that share incentives are becoming a more important part of their talent strategies, but many SMEs still find private company share plans difficult to navigate in practice,” he points out.
“Clients tell us that simpler rules, clearer guidance and more consistency around valuations would give them greater confidence to implement plans more widely. We also hear that mechanisms which help employees manage ‘dry tax’ situations, or create more predictable liquidity pathways, would make equity participation more accessible for a broader group of employees.”
