Many employers may be setting their sights too narrowly in the search for a replacement to profit-related pay (PRP).
PRP was a tremendously popular scheme among employers and employees alike. But it became a victim of its own success, when tax relief was phased out in the November 1996 Budget.
For profit periods beginning in the 1998 calendar year, the tax-free limit on PRP has been halved to #2000. Next year the limit will be halved again and thereafter PRP will be abolished completely. So what are the alternatives?
A range of options exist which can achieve similar objectives to PRP and also carry tax advantages.
Long-term incentive plans (L-tips) have to date been designed for key executives. However, there is no reason why the same principles cannot be used in designing a plan for all employees. Most L-tips involve an upfront award, which the employee will receive in whole or in part at a specified time in the future, subject to the company achieving certain financial targets.
L-tips do not carry the sort of tax advantages associated with PRP or indeed approved share schemes. Nevertheless, they have become popular over recent years as they do provide a valued incentive with a strong emphasis on employee loyalty.
Furthermore, the award can take the form of shares in the company or cash. As a result, this kind of initiative is open to unincorporated businesses such as professional practices.
Flexible pay schemes provide another way of preserving the bonus culture employees have become used to under PRP.
At the same time they provide employers with the benefits of a variable instead of fixed overhead. This is achieved by splitting future pay awards into fixed and variable elements.
The variable element is linked to the employer's financial performance. If this kind of award is made in consecutive years and accumulated, it would not take long before say 5% of payroll costs could be linked to company performance.
The scheme can be administered in a similar way to PRP, with a formal set of scheme rules. An audit sign off provides employees with comfort on the operation of the scheme.
Pension schemes may also be used to achieve or enhance tax efficiency. Providing they are structured correctly, there may be scope for employees to ''sacrifice'' bonuses to an approved pension scheme. Employees considering bonus sacrifice arrangements should ensure that the pension scheme does not become over-funded so that all or part of the bonus sacrificed is effectively lost. This is particularly important where an employee is subject to the ''capping'' regime.
The employer should be careful to ensure that the sacrifice of the bonus does not result in an extraordinary contribution to the pension scheme for which tax relief may have to be spread over a number of years.
q Patricia Ritchie is the Partner in Charge of Tax for Deloitte & Touche in Scotland.
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