There’s more to staff incentive schemes than rewards
Published on November 16, 2010 under Fringe Benefits Tax
Employee incentive schemes are a common strategy to increase loyalty, improve motivation and productivity and also reduce employee turnover, particularly for key staff members.
Although recognising the benefits of introducing a scheme, many businesses don’t consider the financial and tax implications involved and can end up implementing a scheme that costs more than it should or worse isn’t compliant with regulations.
To be truly successful a staff incentive must tick a few boxes. As well as being valued by employees, effective in driving performance and productivity and reflect the organisation’s goals, an incentive scheme should also safeguard the company’s financial interests and ensure it is not exposed to unnecessary liability.
Each and every scheme has different taxation and compliance implications. In essence the Australian Tax Office (ATO) has ensured that an employer cannot give an incentive to an employee without it being considered remuneration to the employee in some manner. However some incentives are more attractive than others on how they are taxed and the associated costs.
For instance schemes that award extra leave time to employees can be extremely tax advantageous as the actual cash outlay to the employer is nil. Equity incentive packages, although they can be complicated, they can also be a tax effective way of incentivising staff.
Fringe benefits tax
The tax mainly associated with staff incentives is fringe benefits tax (FBT) and it represents a cost to the employer. According to the ATO, FBT is a tax paid on certain benefits you provide to your employees or your employees’ associates and it is based on the taxable value of the fringe benefits you provide.
FBT impacts non-cash incentives, such as gifts, company cars, reimbursements, accommodation and salary sacrifice schemes. There are work-related items however that are exempt from FBT. These include portable electronic devices, like a laptop, computer software and items considered tools of the trade.
It might seem like a fun idea to reward your staff with movie vouchers or to even pay their health insurance, but if you don’t factor in your FBT obligations the business could end up paying almost double the cost.
FBT is a major component of salary packaging which used to attract talented senior staff. For instance the costs associated with relocating, a car and self education. Some items are FBT exempt, such as relocation whereas others are not, like self education and some the business may be able to receive a concession on, for instance a car.
A common FBT mistake made by small businesses running their business through a company is they don’t consider the directors as employees and as such fail to understand that certain benefits provided to the directors, like paying a home telephone expense, may attract FBT obligations for the company.
Equity incentives like employee share schemes are known to be a good method of facilitating long term commitment towards the common goal of building the company. Without having to outlay cash up front, a business can tie in an employee’s performance with the objectives of the organisation while at the same time being tax effective and having a positive effect on the business’ bottom line.
These types of arrangements can also play a big part in start-ups and in succession planning when you want to tie in the interests of senior staff members who are likely to play an integral part in building and sustaining the business or are pegged to take over the organisation.
However, they can be complicated and costly to set up and legalise. In many instances the business will need to establish a trust or a special purpose company to administer the scheme and from which to issue shares or rights from.
There are a number of different ways to structure an employee share scheme and the structure will determine the way the shares will be taxed for the employee, either taxed up front with or without a reduction or tax-deferred through a salary sacrifice agreement or under ‘real risk of forfeiture’.
Real risk of forfeiture refers to the type of schemes which include certain conditions for the employee, such as remaining within the business for a specified time period or the company achieving certain profit or growth targets and there is a real risk the employee may lose or forfeit their shares if these conditions are not met.
For example, Kim works for Professional Services Ltd and is granted rights to acquire shares in Professional Services Ltd under an employee share scheme. Under the conditions of the scheme, Kim’s rights to acquire shares will lapse if she stops working for Professional Services Ltd within the next 12 months.
Some key things to consider when implementing employee share schemes:
- Establishing provisions if a staff member leaves the organisation regarding what happens to their shares
- The value of the business in order to ensure the cost of the shares are realistic and at market value
- Private companies may need to make provisions to ensure that control of the company remains with the directors, for instance by issuing B Class shares will give employees equity without having a formal voice in the management of the organisation
- The employer will also have to consider how the employees will ‘pay’ for their shares. If an employer may provide shares to the employee at a discount (below market value) then the Employee Share Scheme tax laws will apply. If shares are not granted at a discount, these laws will not apply, however, the benefits may be taxed in other ways, such as capital gains tax.
Whichever scheme your organisation chooses to incentivise staff, it is just as important to consider the financial, tax and compliance implications as it is to ensure the scheme will engage your team in order to drive the business to achieve its objectives.