A Company Share Option Plan (CSOP) enables a company to grant share options to selected full-time directors and employees over shares at a market value agreed with HMRC at the date of grant (the exercise price). The acquisition of shares on the exercise of the option three or more years after the date of the grant will be free of income tax and National Insurance contributions (NICs).
When will a CSOP be appropriate?
A CSOP is a discretionary plan, which means that companies can select particular directors or employees to benefit, rather than an all-employee plan such as the approved share incentive plan (SIP) or Save As You Earn, where all eligible employees and directors must be invited to participate.
As there are no limits on company size or number of employees (unlike the Enterprise Management Incentive Plan (EMI), a CSOP can be used by larger companies, listed organisations, and those whose trade excludes them from implementing an EMI scheme (such as accountancy or banking businesses).
However, a CSOP is more restrictive than the EMI as:
- Options must be granted at market value
- Each employee can only be granted up to £30,000 of options
- Any gain made by the individual is only exempt from income tax if the options are held at least three years.
An individual can hold CSOP options over shares with a value of up to £30,000. This amount is calculated using the HMRC-agreed market value which for employees, as minority shareholders, will usually be heavily discounted, such that the £30,000 limit is actually worth four or five times that amount as compared to the undiscounted market value.
Which companies can use a CSOP?
In order to grant a tax-favoured option under a CSOP, a company must either be a listed company or, if unlisted, the company must be independent and not controlled by another company.
Who can be granted an option?
Any employee is eligible, but only executive directors working at least 25 hours a week for the company are eligible – non-executive directors cannot participate. There is no working time requirement for employees who are not directors.
Individuals with a material interest – broadly a 30% shareholding – in a close company whose shares may be acquired under the CSOP are also unable to participate. In considering whether an individual has a material interest, it is necessary to take account not only of shares or rights that the individual holds in his or her own name but also those held by associates. An ‘associate’ is defined to include any relative of an individual. A ‘relative’ means spouse, civil partner, parent, child or remoter relation in the direct line or a sibling. Specifically, it does not include brothers- or sisters-in-law or nephews and nieces, aunts, or uncles.
A close company, for the purposes of UK tax law, is broadly a company which is controlled by five or fewer participators. A participator is any person having a share or interest in the capital or income of the company, including a person who possesses or is entitled to acquire share capital or voting rights in the company and a person who is a loan creditor of the company.
Requirements for the options themselves
Share options must be granted with an exercise price which is equal to or exceeds the market value of the share at the date of grant.
The shares issued under that option must fulfil certain conditions, including that they must:
- form part of the ordinary share capital of the company; and
- be fully paid up and not redeemable.
The shares used in the CSOP qualify if there is only one class of shares in issue. If there is more than one class in issue, the majority of shares of the same class as the CSOP shares must be either ‘employee control’ shares or ‘open market’ shares. Shares will be employee control shares if employees and directors (and former employees and former directors) control the company by virtue of holding shares of the same class as the CSOP shares. Shares will be open market shares if (broadly) the majority of shares of the same class as the CSOP shares are not held by persons who acquired them by reason of their employment or directorships (or by trustees who hold such shares on their behalf).
It is this employee control requirement that can make it difficult for a private company to grant options over a special class of non–voting shares. However the shares under option can be subject to restrictions, therefore one approach could be to grant CSOP options over ordinary shares but to attach restrictions on voting when issued.
Limits
The Maximum value of shares over which a participant may hold subsisting CSOP options is £30,000 (calculated using the market value of the shares on the grant date). As set out above, the value of the shareholding for tax purposes will usually be heavily discounted to reflect the fact that it is a minority shareholding. Furthermore, a £30,000 share award in a large company will be a small fraction of the value of the company as a whole.
This relatively low individual limit makes CSOP attractive for companies wanting to make small awards to a large number of participants. Many companies with CSOPs also have unapproved discretionary share option plans under which options with larger values can be granted.
When can an option be exercised?
The conditions are met if the option is exercised within 10 years of grant and:
- The exercise is at least three years after the grant date, or
- Within six months of cessation of employment for certain “good leaver” reasons
- By the participant’s personal representatives within 12 months of death, or
- Within six months of certain cash takeovers.
Companies can also make exercise conditional on specified performance targets; these conditions should be set out in the option agreement at the date of the grant. The share options will then become exercisable when the performance targets are met.
The company can include a rule in the plan to permit option-holders to sell some of their shares on exercise to fund the exercise price payable.
Tax treatment
For individuals exercising CSOP options in approved circumstances, the main advantage of the scheme is that any increase in the value of the shares between the grant and the exercise of the share option is delivered free of income tax and NICs.
Where an option exercise qualifies for income tax and NIC relief, gains made on the subsequent sale of the option shares (compared to the exercise price) are still subject to CGT. However, individuals benefit from a CGT annual exemption (of £12,300 for 2022/23) and gains after the deduction of the allowance are subject to CGT at 20% (or 10% where individuals qualify for Business Asset Disposal Relief).
Where share options are exercised within 3 years of the date of grant (other than in the specified circumstances set out above), income tax will be due on any increase in value between the market value of the shares at the date they are acquired and the exercise price. This may be collected under Pay As You Earn (PAYE) arrangements if the shares are “Readily Convertible Assets” at the time, in which case NICs (including employer NICs) will also be due.
The company should qualify for a corporation tax deduction when the option is exercised. The tax deduction is calculated as the difference between the exercise price, and the market value of the shares on the date the options are exercised.
