Restricted share ‘clog’ schemes: Everything you need to know

Content Team June 15, 2022 mins read

About the team

Global Shares’ Content Team comprises a dynamic and talented team of writers and experienced professionals who strive to deliver useful equity insights and simplify complex equity information, all with the aim of helping you to better understand equity management.

Restricted share ‘clog’ schemes: Everything you need to know

Attracting and retaining key personnel is one of the biggest issues facing companies around the world today, and Ireland is no exception.

Some industries and sectors are feeling this pressure more than others, but no one is immune. The challenge is perhaps most keenly felt among startups and smaller companies with high growth potential who find themselves competing with multinationals and other large operators for the finite pool of top talent that can help new or still developing businesses fulfil their growth potential.

Using share plans to attract key talent

Such companies can’t match giant competitors on salary, so they must make themselves competitive in the recruitment sphere in other ways. That’s where employee share plans come in. Generous equity packages can enable startups to catch the eye of the talent they need. In this, a startup makes a virtue of its status as a new kid on the block. Essentially, the pitch becomes, “Yes, you will most likely get a higher salary on day one with Multinational X, but if this business develops as we believe it can, the shares we’re offering now may prove to be worth many multiples of their current value down the line.”

This kind of offer is one of the ways in which a startup can hope to outflank a larger, more established competitor. Share options or awards in a large enterprise may be attractive in their own right, but by the time a company has grown to a certain level, been taken over, or gone public, those shares have become a known quantity, i.e., the value of those shares has been largely established and so there is more potential for new hires to hit “the jackpot” by joining a startup in the early phase of its development.

There are no guarantees, of course, but that is generally the choice facing individuals fielding interest from suitors large and small, established and new – go with the higher salary offer or get in on the ground floor with a new company that may be going places.

The key for startups, whether in Ireland or elsewhere, is to have the leeway within existing legislation on employee share plans in their jurisdiction to be able to make the kind of offers that will enable them to attract and then retain the difference-making individuals they need to move the business forward.

Employee ownership in Ireland

While it’s fair to say Ireland hasn’t been a trailblazer in the area of equity incentives in the workplace, some progress has been made in recent years, with the Government heeding calls from employee ownership advocates and indicating a willingness to explore ways to reform and expand the area in Ireland.

Ireland is still playing catch-up to a degree, but that doesn’t mean that businesses here don’t have the ability to use equity-based incentives when looking to attract new personnel.

The Revenue Commissioners preside over a system under which businesses can choose from schemes that require prior approval, e.g., the Approved Profit Sharing Scheme (APSS) and savings-related share options schemes such as a Save As You Earn (SAYE).

These schemes serve a good purpose, but one potential drawback, depending upon what an individual business is looking to accomplish when introducing a share plan, is that Revenue-approved plans have to be offered on an all-employee basis as long as specified eligibility criteria are met, usually related to length of time on the payroll. This may or not prove to be a sticking point, but it is not unusual for businesses to want to have the leeway to pick and choose who they target, or at the very least to go with a plan where they may choose to include a wide swathe or even all of their workforce, but one that gives them the ability to narrow the focus to senior executives and other key personnel, if that is what they deem to be in the best interests of their business.

Restricted share schemes – the key details

When a company wants to offer a share plan with the latter strategy in mind, they can opt to go with a scheme that does not require prior Revenue approval.

One such approach would be to go with a Restricted Share Scheme (RSS) – also known as a clog scheme.

Under an RSS, a company awards free shares to selected employees, with the terms of the deal stating that the shares must be held for a specified period of time – known as the clog period – before recipients can look to transfer or dispose of them. The rules of the scheme dictate that the clog period must be for at least one year, but depending upon the terms of an individual scheme it can last for much longer than that, up to five years or even more.

The initial step-by-step sequence unfolds as follows:

#1: The company sets up a trust for the specific purpose of holding shares awarded under the scheme for the duration of the restriction/clog period.

#2: The company formally approaches the individuals it wants to participate in the scheme, offering specific details on the number of shares being offered and the proposed length of the clog period.

#3: If those approached find the terms agreeable, they must then reply in writing indicating that they accept and want to participate.

#4: By indicating their acceptance in writing, scheme participants also agree to the key provision that the shares will be held in the trust for the specified clog period – whether one, three, five or whatever number of years – and that they will therefore not be able to transfer or sell any of those shares during that time, with exceptions made in a small number of circumstances, more on which later.

What about taxation?

An RSS or clog scheme is effectively an alternative to a cash bonus and is treated in a more tax efficient manner, for both employer and employee alike, which is one of the main attractions of the scheme.

Whereas with a cash bonus, recipients will be liable for 40% income tax, as well as employee PRSI and USC, which can take the tax bill up to as high as 52%, reduced levels of all three apply for a clog scheme, with the extent of that break linked to how long the clog period is scheduled to last.

Looking at income tax, Revenue assesses the initial charge based on the market value of the shares at the time they are awarded, and the rate of abatement is then calculated. More specifically, current tax rules in this jurisdiction provide for a 10% reduction in the amount deemed taxable for each year of the clog period. So, if the clog is set at one year, that will translate into a 10% reduction, for a three-year clog the reduction is 30%, for five years it is 50%, and the abatement is capped at 60% for schemes where the restriction is in place for more than five years.

The following example shows how this might play out in a real-world scenario:

For the employee:

  1. An employee is awarded free shares with a market value of €20,000 and the clog period is set for four years.
  2. The taxable gain at the outset is €20,000.
  3. Revenue is made aware of the RSS and the four-year restriction, so a 40% abatement is applied.
  4. The total abatement is €8,000.
  5. This means that just €12,000 (€20,000 minus €8,000) is treated as taxable, and so the income tax liability is calculated from that figure.
  6. Based on an income tax rate of 40% (we exclude employee PRSI and USC here, with a view towards simplifying the example), the post-abatement bill will be €4,800, as opposed to €8,000, which would have been the charge if based off the full €20,000 value.

For the employer:

  1. Whereas with a cash bonus, an employer may be liable for PRSI up to 11.05%, this contribution is not levied when the bonus takes the form of restricted shares. In the above example, had an employer given an employee a €20,000 cash bonus, at the 11.05% figure, they would have been liable for €2,210 in PRSI.
  2. Companies can claim a deduction against corporation tax for the cost of setting up and running the scheme.

While the scenario outlined above shows the obvious tax advantages of restricted shares for employer and employee alike, one potential complication is that the tax bill is payable immediately, even though scheme participants may not be able to touch the shares for up to five years or more.

The abatement process itself is in part a response from Revenue to this point, in that what is effectively a tax discount takes into account the fact that the rules of the scheme prevent affected individuals from accessing the very shares they are being taxed on at the point that the bill comes due.

Depending upon the circumstances of the individuals involved, dealing with the upfront payment may or may not cause a headache, but this point underscores why in practice a restricted clog scheme tends to be reserved for senior executives and other key individuals, as opposed to being used for all employees.

Under the existing rules, all income tax, PRSI, and USC due on share awards made under an RSS must be collected by the company through the PAYE system and submitted to Revenue in the same month the awards are made.

With an eye on the potential difficulties that the upfront payment might create for some individuals, Revenue allows for the sale of whatever number of shares may need to be disposed of in order to meet the tax bill, though no relief is offered on the sale of those shares.

In some instances, a company may award individuals an additional cash bonus with a view towards covering the bill, though, again, no special tax treatment will apply under those circumstances, which, from the employer’s perspective, is less than ideal as it adds to the overall expense.

It is also worth emphasising that because the tax is calculated and paid based upon the value of the shares at the time of the award, participants stand to benefit even more if the value of the shares increases during the lifetime of the restriction. For example, if shares valued at €20,000 at the outset are worth at €40,000 at the end of the restriction period, no additional income tax will be applied.

So, here, with the four-year clog outlined above, the final income tax figure will be the €4,800 paid upfront, irrespective of whether those same shares are worth the same or have doubled or trebled in value during that time. Of course, the same also holds in the event of shares losing value during the restriction period, though, of course, the hope will always be that the value of the shares over time will move in the desired direction.

What if the terms are changed?

As detailed previously, the tax bill for an RSS is calculated and paid at the outset. So, if a scheme comes with a four-year clog, Revenue calculates the tax liability based on the assumption that the shares will be restricted for the full four-year period.

However, this will not always be the case. Situations can arise, either at the individual or company level, which will see the shares released earlier than had been initially agreed.

At the individual level, assigned shares can be transferred or otherwise disposed in the event of the death of a scheme participant.

At the company level, a takeover might see the entire issued share capital being bought, and in those circumstances the sale restriction on RSS participants can be lifted under “drag and tag” provisions.

However, whatever the circumstances around a change of terms, the Revenue position is clear – whatever abatement was awarded at the outset must be clawed back if the scheme does not adhere to the original timeline. In practice, this means that the original tax bill will be recalculated and whatever shortfall is found must be paid.

So, if a four-year clog is lifted after two years, the abatement will be retrospectively adjusted to effectively reclassify that scheme as having only had a two-year clog.

Using the example provided earlier, this recalculation would work as follows:

  1. Participants were awarded shares worth €20,000 on a four-year clog. Based on that, a 40% abatement was applied, meaning that only €12,000 was deemed to be taxable income, which led to an upfront income tax bill of €4,800 (based on a 40% rate).
  2. If the restriction is then lifted after two years, Revenue will recalculate the tax bill based on that timeline.
  3. The abatement is now reassessed as being 20% of the original value – €4,000. Therefore, the revised calculation states that €16,000 of the original €20,000 is taxable income.
  4. The income tax bill (40%) is now €6,400 of which €4,800 was paid upfront based on the now no longer applicable 40% abatement.
  5. In line with the recalculation, affected participants now owe an additional €1,600 (€6,400 minus €4,800).
  6. Depending on the circumstances, this updated charge will be accounted for either by the employer through the PAYE system or impacted individuals using the self-assessment system.

What are the tax implications at disposal?

After the restriction period ends, scheme participants can choose to dispose of the shares if they wish. When these shares are sold, that transaction will be subject to Capital Gains Tax (CGT) of 33% on any gain made.

What constitutes a “gain” in Revenue terms relates to the difference between the sale price and the acquisition cost of those shares. That cost refers to whatever price was paid for those shares in the first instance and whatever tax payment was associated with that transaction.

In line with the example used here, scheme participants were awarded free shares and then paid a tax bill based on an abatement calculated in line with length of the clog period. The difference between that tax bill and the ultimate sale price – in the event of a gain being secured at disposal – will be the portion of the sale proceeds subject to CGT.

So, using the initial tax bill we highlighted in our example, if a participant paid €4,800 in tax at the outset and then at the end of the clog period disposed of all shares for €25,000, €20,200 of that latter sum would be liable for CGT.

While the standard rate of CGT is 33%, which in the scenario above would translate into a bill of €6,666, it is possible in some circumstances to secure a lower rate – 10% CGT Entrepreneur Relief.

Eligibility for this relief is linked to the following criteria:

  • Full-time employees who have held their shares for at least three years.
  • Individuals must hold at least 5% of the total ordinary shares in the company.
  • Even if the above two points are met, there are specific exclusions for shares in companies involved in land development or investments.

What are the reporting obligations?

As stated, prior Revenue approval is not required when setting up an RSS, but Revenue must be informed on the setting up of the scheme and awarding of shares, with a view towards facilitating the payment of the upfront tax bill through PAYE.

In this scenario, employers must also complete the relevant sections in the Employer’s Share Awards Return (Form ESA) by March 31 following the relevant tax year.

Revenue provides full details on how to proceed and other information on restricted shares on its website.

Why an RSS works for employers

The company is safeguarding its shares, in that the restriction clause prevents any disposal during the lifetime of the clog, bar in the limited circumstances detailed above.

  • Companies can claim a tax deduction on the cost of setting up and running the scheme. 
  • Employers make no PRSI contribution.
  • An RSS can be useful when looking to build a stable senior team. Th scheme allows employers to target specific employees, and by giving them a formal stake in the company – with the restriction attached – you make them more likely to stay with you into the long-term.

Want to learn more?

If you want to roll out a restricted clog scheme in Ireland or learn more about this type of plan, give our team a call by filling in the form below.

Get in touch

Please Note: This publication contains general information only and Global Shares is not, through this article, issuing any advice, be it legal, financial, tax-related, business-related, professional or other. The Global Shares Academy is not a substitute for professional advice and should not be used as such. Global Shares does not assume any liability for reliance on the information provided herein.

Enjoy our latest posts

Food for Thought

Sign up to receive bite sized brainfood on a range of topics that will help your business grow.