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Dividend tax changes may “change the landscape”

The withdrawal of tax credits and introduction of a “dividend nil rate” tax band is likely to prompt companies into rethinking their policies in relation to employee share participation.

The opportunity for many employees to receive dividend income of up to £5,000 per year free of tax may encourage companies to look again at ways of enabling employees to acquire and hold shares in a tax-efficient manner.

One obvious way of doing so is for the company (or group) to establish a qualifying Schedule 2 share incentive plan (“SIP”) under which employees may acquire shares by purchase (“partnership shares”) or gift (“free” or “matching” shares).

It is now open to an independent company, a company under the control of a listed company, or a company owned by an “employee ownership trust” to establish a share incentive plan using fully-paid ordinary shares of a class with restrictions which, in effect, would allow employees to benefit from the payment of tax-free dividends of up to £5,000 (where they have no other dividend income in the tax year) on such shares only for so long as they remain in employment with the company or group.

That said, care must be taken in structuring such an arrangement to avoid employees properly being charged to income tax on their dividends as if such income was a “re-direction of earnings” (as to which, see the commentary on the “Glasgow Rangers’ case”).

There may also be difficult questions arising as to what is the “market value” of such “restricted employees’ shares”. Prima facie, the value of a holding of shares which is acquired with an expectation that it carries an annual (and possibly tax-free) dividend of £5,000 is likely to be of substantial value far in excess of the statutory limits on the acquisition of shares under a share incentive plan.

It should be noted that, in theory at least, a company owned by an employee ownership trust and whose employees hold shares (either directly or under a share incentive plan) should, if properly structured, be able to pay to each employee every year bonuses of up to £3,600 as well as dividends of up to £5,000—an aggregate tax free income of up to £8,600.

Pett, Franklin & Co. LLP are experts in employee share schemes, share plans and executive incentives. To find out how we can help you, call David Pett on 0121 348 7878 or email David at david.pett@pettfranklin.com.

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