Company Share Option Plan (“CSOP”) Factsheet

A CSOP is a tax-advantaged share option plan set out in the UK tax legislation. It allows companies to grant share options to their employees and full-time executive directors (together referred to hereinafter as ‘employees’ or ‘participants’), aligning interests of the participants with the existing shareholders, fostering long-term commitment and performance, in a tax efficient way.

Further it is especially useful for companies that do not qualify for an Enterprise Management Incentive (“EMI”) plan (another type of tax-advantaged share option plan).

Key Features of a CSOP

A CSOP provides employees the opportunity to purchase shares in their employing company or its parent company as relevant (the option), at a point in the future (known as the exercise date), for an agreed fixed price (the exercise price), which is set at the time the share options are agreed (known as the grant date).

1. Eligibility Criteria

• Eligible Companies: Any company (private or public) can implement a CSOP, unlike EMI plans which have specific restrictions based on company size, gross assets, and industry. However, similarly with EMI, the company issuing the CSOP options cannot be under the control of another company.
• Eligible Employees: Any full-time or part-time employee (directors must be full-time, meaning at least 25 hours a week) can be granted an option under a CSOP. There are no restrictions based on the number of working hours or employee rank.

2. Option Grant Terms

• Maximum Value: Employees can currently be granted options over shares worth up to £60,000 at the time of the grant (based on the unrestricted market value (“UMV”) of the shares at that time). When determining this value, it is possible to apply a minority discount to reflect that the shareholdings under option are minority interests, which have a lack of influence and prior to an exit event, a lack of marketability.
• Exercise Price: Options must be granted with an exercise price at least equal to the UMV of the underlying shares on the date of the grant. Options cannot be granted at a discount under a CSOP. The shares under option must be part of the company’s ordinary share capital, and they must be fully paid-up, non-redeemable shares.

3. Vesting and Exercise Period

• Minimum Holding Period: For the tax advantages to apply (set out below), CSOP options must not be exercised until at least three years from the date of grant (subject to certain exclusions noted below), although companies can choose to impose longer holding periods or additional performance conditions. Early exercise of a CSOP option (i.e. within three years from the date of the grant) will still benefit from the tax advantages in the following specific circumstances:

• Good leavers, if exercised within six months of ceasing employment (i.e., by reason of ill-health, disability, redundancy, retirement);
• Death, if exercised within 12 months; or
• Certain corporate events, if exercised within six months i.e. a cash takeover of the company, a court-sanctioned scheme of arrangement, a shareholder approved reorganisation of a non-UK company’s share capital or a minority squeeze out, provided certain conditions are met.

• Exercise Flexibility: Options should be exercised within 10 years from the date of grant to benefit from the income tax relief. After 10 years, the option will usually lapse if not exercised (or the income tax relief will cease to apply). If the option is not exit only, the option would typically be exercised after three years to help ensure the tax benefits apply, other than in the circumstances listed above, where the benefits would still apply despite an early exercise.

Tax treatment

For Employees:

• Grant – Employees pay no Income Tax, National Insurance Contributions (“NIC”) or Apprenticeship Levy (“AL”) on grant.
• Exercise – Employees pay no Income Tax, NIC or AL on the difference between the exercise price and the share market value, provided the option is held for at least three years – this income tax relief applies for tax-advantaged plans, such as the CSOP.
• Sale – Employees may be liable for Capital Gains Tax (“CGT”) when they sell the shares, and CGT will be payable only on gains that exceed their annual CGT allowance. The difference between the sale price and the exercise price is subject to CGT. On an exit event and  following exercise, the CSOP participants will be able to sell their shares for full value i.e. without a minority discount, alongside the other shareholders to the acquiring third party.

For Companies:

• No Employer’s NIC: Companies do not have to pay NIC on the grant, exercise of the options, or sale of the underlying shares, making this a cost-effective way to incentivise employees (this is on the basis the options are held for more than three years or meet one of the exemptions noted).
• Corporation Tax Deduction: Companies can claim a corporation tax deduction, based on the difference between the market value of the shares at the time of exercise and the exercise price paid by the employee.

Flexibility in Plan Design

1. Customisable Vesting Conditions

• Performance-Based Vesting: Companies can design the CSOP to include performance conditions (e.g., meeting financial targets) before employees can exercise their options.
• Time-Based Vesting: A CSOP can be structured to allow options to vest after a specific period (typically three years), encouraging long-term retention.

2. Discretionary Grants

• Unlike some other share plans, companies can be selective in offering CSOP options, targeting key employees or senior managers only, rather than needing to offer it across all employees.

3. Corporate Events and Termination

• Good Leavers: CSOP rules can include provisions for “good leavers” (disability, injury, retirement, redundancy, a TUPE transfer on the transfer out of the group of the employing company) to exercise their options before the normal vesting period. If the good leaver provisions apply and the grant date is within three years, a good leaver can exercise their option and still benefit from the tax advantages provided this is within 6 months of cessation of their employment.
• Bad Leavers: CSOP rules can also include provisions for “bad leavers”, which typically refers to an employee who leaves a company under unfavourable conditions, such as resignation, dismissal for cause, or gross misconduct. In these circumstances, the option will typically lapse.
• Corporate Events: If a company is acquired or undergoes a change of control, options under a CSOP may be exercised early i.e. where time based rather than simply exit based, allowing employees to benefit from any increase in the share price. Certain conditions need to be met for income tax relief to apply if this is within 3 years as noted.

Plan Requirements and Administrative Aspects

1. Share Valuation

• Market Value Determination: The market value of the shares must be established at the time of granting the options as this should be used to set the minimum exercise price. HMRC approval is not compulsory, however, as shares under a CSOP plan cannot be granted at a discount to unrestricted market value, approval from HMRC is strongly recommended. This is also helpful in ensuring the £60,000 per participant limit is not exceeded.

2. Plan Approval and Registration

• HMRC Registration: The company must register the CSOP with HMRC and self-certify to confirm the plan complies with the CSOP legislation.
• Compliance Requirements: The company must follow specific reporting and record-keeping requirements, including filing an Employment Related Securities (ERS) annual return with HMRC to report any relevant events i.e. option grants and exercises. The CSOP annual return is due by 6 July following the end of the tax year (6 April – 5 April).

Conclusion

CSOPs are a flexible and tax-efficient incentive plan. They offer benefits to both employees and employers, driving long-term employee engagement and aligning the interests of the workforce with company success.