How a Share Incentive Plan (SIP) works

What is a Share Incentive Plan (SIP)?

A share incentive plan (SIP) is one of the two all-employee UK tax-advantaged share plans introduced in 2000, providing employers with an easy and flexible way to offer shares in the company to their employees.

In the US, we’ve a tax-advantaged ESPP scheme under which employees can purchase stock in their companies at a discount – often between 5-15% off the fair market value (FMV) and enjoy tax benefits. Let’s review their features before discussing SIPs in detail:

How does a share incentive plan work?

A share incentive plan (SIP) works by awarding eligible employees free shares and/or allowing them to purchase shares in their company. The shares are kept in a trust until the employee either leaves the job or decides to take the shares from the plan.

Employees can be offered one or a combination of the following four share awards:

1. Free shares: You can annually give each employee free shares worth up to £3,600 (as of 2023/24). 
2. Partnership shares: You can invite employees to buy partnership shares via deductions from salary pre-tax. They can use up to £1,800* or 10% of their salary each year – whichever is less to buy shares. 
3. Matching shares: Where employees acquire partnership shares, you can give them up to 2 matching shares for each partnership share they buy.
4. Dividend shares: Your employees as a shareholder may be paid dividends on their free/partnership/matching shares. If so, you could allow them to use those dividends to buy more shares. These are dividend shares.

SIP tax rules

Although these four SIP share types have different definitions, their tax consequences are similar. See the breakdowns below:

A. Free Shares

1. Acquire shares:
   When an employee acquires the shares, no income tax or NICs is chargeable on the value of the free shares.
2. Take shares during the first 3 years:
   Pay income tax on the market value of the free shares at the time of withdrawal.
3. Take shares between 3 and 5 years from the date of acquisition:
   Pay income tax on the lesser of:
   – The market value of the shares at the time of acquisition, and
   – The market value of the shares at the time of withdrawal.
4. Take shares after 5 years from the date of acquisition:
   No income tax or NICs is chargeable.

B. Partnership Shares

1. Acquire shares:
   No income tax or NICs is chargeable on the money spent to buy the partnership shares.
2. Take shares during the first 3 years:
   Pay income tax and NIC on the market value of the partnership shares at the time of withdrawal.
3. Take shares between 3 and 5 years from the date of acquisition:
   Pay income tax on the lesser of:
   – The salary used to buy the partnership shares, and
   – The market value at the time of withdrawal
4. Take shares after 5 years from the date of acquisition:
   No income tax or NICs is chargeable.

C. Matching Shares

The tax situations of matching shares are the same as the free shares.

D. Dividend Shares

1. Acquire shares:
   No income tax or NICs is chargeable on the dividends used to buy the dividends shares.
2. Take shares during the first 3 years:
   Pay income tax on the amount of the cash dividend originally used to acquire the dividend shares, at the prevailing dividend rate at the time of withdrawal.
3. Take shares between 3 and 5 years from the date of acquisition:
   No income tax or NICs is chargeable.
4. Take shares after 5 years from the date of acquisition:
   No income tax or NICs is chargeable.

Are share incentive plans worth it for employers?

Provide corporate tax benefits:
You’ll get corporation tax relief for launching and operating the share scheme. Also, there will be no employer’s NIC or Apprenticeship Levy charges you to pay.

Improve productivity:
Employees can be more motivated to work towards the company’s goals as their investment is based upon the performance of the company.

Retain staff & attract talent:
SIP is an effective scheme to reward employees beyond their salaries. If the company succeeds and its value continues to grow, an employee could receive greater financial benefits from share awards than cash bonuses.

But, young employees tend to change jobs every 2.4 years according to the research from ProShares. So, they may be reluctant to tie themselves down to a financial investment for five years.

Are share incentive plans worth it for employees?

Receive financial benefits:
Your share awards could potentially bring your employees substantial financial wealth. If they are given free shares, they basically will earn under any circumstances even if the shares drop because they have paid nothing for them in the first place.

Enjoy generous tax benefits:
The SIP tax benefit is one of the most attractive benefits to employees as discussed. Also, capital gain tax is not chargeable on the increase in value of the shares whilst the shares remain in the SIP trust.

Reduce tax burden via pre-tax contributions
If your employees purchase Partnership Shares, the salary deductions come from pre-tax earnings, meaning they do not have to pay income tax or national insurance on the pay used to purchase the shares.

But, an SIP does involve risks. They cannot choose to take their savings pot back like is possible in the SAYE scheme at the end of the term, even if the market value of the share goes below the value at the time of purchase when the scheme ends.

Here at Global Shares, a JP Morgan company, we know how to guide companies looking to launch their own SIP or any type of employee share scheme because we’ve helped so many to do it – let us help you bring out the best in your plan.

If you want to learn more about SIPs, head over to our SIP UK guide or give our team a call to see how we can support you.