What is the benefit of having Dividend Shares in a SIP?

Posted by RM2 at 08:36 on 5 Jun 2020

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Companies that operate Share Incentive Plans (SIP) for employees will already know about the excellent tax benefits offered by this type of all employee share plan. Ultimately, a SIP can deliver a zero tax rate for participants, making it the most tax efficient share plan available in the UK.

However, Dividend Shares are often the “forgotten relation” in the SIP dynamic. It is not a requirement to offer Dividend Shares to employee participants, but they shouldn’t be dismissed out of hand.

What are Dividend Shares?

Under a SIP, if dividends are paid, the employees are entitled to receive them as if they were shareholders (even though the shares are still held by the trustees of the SIP). Dividends may be received directly as cash (and they would be taxed as dividends in the hands of the employee in the normal way).

Alternatively, the dividends can be reinvested in the acquisition of further company shares. Those shares are known as Dividend Shares. That reinvestment is made without any tax deduction, and there is no requirement to disclose the details on the individual’s tax return.

The amounts of the dividend paid must be reasonable in all the circumstances. HM Revenue & Customs will penalise companies which seek to place “excess” dividends in the hands of the employees, since this is regarded as avoidance of national insurance contributions.

The company operating the SIP can maintain an element of control over the process as they decide (in the Plan Rules and the agreements with participants) whether the participants can choose to take their dividends as cash or shares or whether to make it compulsory for participants to elect for dividend reinvestment.

How are Dividend Shares taxed?

The Dividend Shares must be left in the SIP for three years otherwise income tax is due at the dividend rate.

However, there is no charge to income tax where the Dividend Shares cease to be subject to the SIP because the participant is no longer in relevant employment for “good leaver” reasons. Those include injury, disability, redundancy, TUPE transfer, retirement or death. They also include a change of control by way of a general offer – which is a more narrowly defined provision than a conventional share purchase agreement so take care in this regard.

In relation to capital gains tax (CGT), provided the Dividend Shares are held within the SIP for whole three year holding period, there is no CGT liability when the Dividend Shares cease to be subject to the Plan.

Hence a taxable dividend can ultimately become a non-taxable “Dividend Share”.

What else should I know about Dividend Shares?

Dividend Shares cannot be subject to forfeiture provisions (the same position as for Partnership shares). The rationale for this is that like Partnership Shares the participant has actually paid for the shares (unlike with Free and Matching Shares) and therefore these shares should not be subject to forfeiture provisions.

As a separate and not entirely unrelated point (but worth bearing in mind for companies and SIP trustees who operate a SIP), dividends received by the SIP trustees on shares which have not yet been appropriated (i.e. the shares are currently being warehoused in anticipation of being allocated as Free, Partnership, Matching or even Dividend Shares) are free of tax as long as the shares are appropriated within two, or five years if the shares are not readily convertible assets.

In conclusion, naturally with dividend reinvestment, there will be an element of extra administration for the SIP. However, in terms of employee incentivisation alignment, RM2’s view is that this provides plenty of “bang for your buck”.

If you would like to know more about any element of the Share Incentive Plan then contact us at enquiries@rm2.co.uk