Don’t punish staff for taking stake in their firm

Figures from the business information company Vision-net showed that 25 Irish companies collapsed in the space of a week recently, as the aftershocks from the recession continue even if parts of the economy are looking rosier.

It was also reported that these companies had left thousands of unpaid invoices behind them, not an uncommon occurrence when businesses fail, but a potential disaster for companies that haven’t been paid. For most directors and owners, there is usually little or no blame attributed to them when this happens but it can still lead to job losses when an otherwise viable business has its cash-flow squeezed by unpaid bills.

Staff costs are a significant factor in any business and one way to help improve cash flow is to allow employees take a portion of their pay in the form of equity in their employer’s firm. This has the double benefit of reducing a firm’s monthly wage bill while turning the employee into a long-term business owner with all of the substantial benefits that brings with it – as detailed in the UK government-commissioned Nuttall Review.

However, the Irish ProShare Association (www.ipsa.ie) has identified a major problem that is an unnecessary roadblock to this innovation being adopted. Under our tax laws an employee who takes a pay cut and gets a benefit in return remains liable to tax on the forgone amount. So, an employee who takes shares instead of cash gets taxed as if the shares were cash.

Employees' conundrum
This is the conundrum. An employee opts to take shares in his company to help his company and his job survive. But the tax authorities deem to this to be cash and he has to pay tax on this 'cash' immediately. But the employee obviously has not got the cash so now he cannot afford to take shares. Either way, he loses.

And here is an example of how it doesn’t work: John and his colleagues work at Joe’s Plumbers, where he has been for 10 years. The company has short-term financing difficulties but John is confident about the firm’s future and believes the cash shortfall is only temporary. During discussions with staff and management on cost saving measures, a pay-cut in exchange for taking company shares is suggested. This idea appeals to the staff.

At the same time, the business owner begins to see that not only could this plan rescue the business but longer term it might also be his retirement plan. By allowing employees to have shares at an agreed price, he may not have to sell his company under duress at a knock-down price, probably in a trade sale to a competitor. Everybody wins, apparently.

However, as soon as the ‘salary sacrifice rules’ are mentioned, the plan falls apart. John and his colleagues cannot realistically be asked to commit economic suicide by taking a pay cut while still having to fund a tax liability for cash they have not received. So, the plan falls apart, the company’s finances worsen, redundancies follow, key talent is lost, corporate memory disappears, problems get worse, eventually leading to insolvency.

Now the exchequer has to forgo far more than any deferred tax on the company’s shares. While it might be unfair to say that the tax system put John out of a job, it certainly did not help to save it. Nobody set out to create this problem but there is no excuse for such a ridiculous set of rules.

Exchequer loses out
It should be remembered that, unlike those tax reliefs where the exchequer loses out on the tax completely, under this type of proposal the tax is simply deferred but not removed. The tax will be paid once the shares are sold or employment with the company ceases.

Further protection can be added without depriving these schemes of their effectiveness. The Tax Strategy Group, an inter-departmental group of officials that advises the Minister for Finance on the budget, considered a similar scheme in 2012. It involved giving some element of tax relief to employees for lending money to their employers but this pro-job innovation did not make it into the budget.

At IPSA, we are proposing a simple innovative solution at zero cost to the exchequer that we believe could make a big difference to struggling businesses, and which in turn could make a big difference to employment as well as the economy as a whole.

Businesses would welcome its inclusion in the forthcoming Budget.

The author is a Council Member of the Irish ProShare Association, an independent national association engaged in promoting forms of employee financial involvement