‘Dividend equivalent’ shares
Employees may receive an award of shares under a discretionary share plan such as a Long-Term Incentive Plan. There is a period between when the company makes the award, ‘the grant’ and when employees receive their shares at the end of the ‘vesting period’. During this period the employee doesn’t own the shares and doesn’t receive dividends.
To keep the economic value of the award comparable to owning the shares outright, some companies choose to pay award holders a dividend equivalent in cash or by giving additional shares that are added to the original award. This normally occurs when the plan vests and the plan shares are released to employees. When this happens, the cash or share value will be processed through payroll as taxable employment income with deductions for income tax and national insurance contributions, and therefore not reportable as dividend income.
When employees are granted their share award, they will receive information about whether a dividend equivalent applies and whether it will be paid in cash or additional shares.
EQ analysis across 109 companies
- 52% pay a dividend equivalent on their discretionary awards
Of those:
- 9% pay the dividend in cash
- 89% pay the dividend in shares
- 2% pay the dividend in both cash and shares (depending on the plan)
Where the dividend equivalent is paid in shares:
- 56% calculate the dividend on a compounded basis
- 44% calculate the dividend on a simple basis
Conclusion
Just over half of companies pay dividend equivalents on discretionary share plan awards, usually in shares and often using a compounded calculation. Dividend equivalents are taxed as employment income, not as dividend income.
The information contained in this article, in relation to tax, is a general summary and is for guidance only. It is based on tax legislation and regulations for UK individuals. If you are in any doubt about your own tax position, you should seek your own tax advice on the personal tax implications of holding shares.