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Employee Participating Plans aka The Phantom Stock Plan

23/04/2013


Have you wanted to include employees in your Company’s growth, but don’t want to include them as a shareholder?

Maybe a participating plan would meet your needs.

A participating plan allows employees to share in the future growth of your organization. There are no shares involved in a participating plan; rather, the employee is rewarded for future growth from a baseline value at the onset of their participation. The participant can see their relative value increase as the value of the Company increases as they will be allocated a percentage of the growth. These are often called phantom stock plans as the participating employees almost mimic shareholders.

Eligibility

Eligibility can be based on position, years of service, performance, or a combination of these factors which you can decide based on your goals.

Triggering Events

The employee’s value is paid out on the occurrence of certain predetermined triggering events. There is flexibility in determining which events result in a payout. Common triggering events include:

  • Sale of the Corporation to a third party
  • Merging of the Corporation with another Company
  • Death of a participating employee
  • Purchase of shares of the Company by the employees
  • Quitting
  • Layoff
  • Permanent disability

When setting up a participating plan for your employees, you can determine which triggering events automatically cause a payout, and which result in no payout. Often there are vesting terms embedded in the participating plan to help manage this. For example, these plans are often implemented for employee retention, and quitting may not be a triggering event and therefore there would be no payout. On the other hand, if the Corporation is sold to a third party often the employees receive a full payout. Similarly, if in the future the participating employees have the opportunity to purchase shares of the Company, their existing value in their “growth” account would be applied against the purchase price.

Taxation of Payments

There are two types of payouts a participating employee can receive from the plan; distributions (similar to dividends on shares) or the full payout of value (similar to the sale of shares). Both types of distributions are treated as employment income for tax purposes.

Benefits of a Participating Plan

The participating plan can reward employees for growth in value, but does not have a transfer of beneficial interest, voting issues, shareholder issues and other complexities.

Employees are not required to invest funds into the Corporation, and therefore there is no capital requirement to restrict their participation in the plan.

What is Involved?

It will be necessary start with the baseline value. The increase in value each year must be calculated and would be communicated with the participating employees. The terms and conditions surrounding your participating plan should be predetermined so there is certainty of how to deal with future events.

A participating plan or an employee share ownership plan may provide many benefits to your organization. If you are interested in learning more, please contact your local MNP Tax Advisor.