More companies than ever are looking to offer incentives to their employees in the form of share ownership. Research has shown that employee-owned businesses are faster growing, more productive and more profitable, so it’s no surprise that these schemes are so popular. If you’re thinking of setting up a company share option plan (CSOP), it’s important to take expert legal advice to make sure it’s the right route to take. If you set up a formal plan both your company and your employees can obtain significant tax breaks.
So, what do you need to weigh up before setting up a CSOP? Are you eligible, what are the formal requirements and qualifying conditions, and should you set one up?
Jump to:
- What companies are eligible to set up a CSOP?
- Who is eligible to participate in a CSOP?
- What are the legislative requirements for setting up and managing a CSOP?
- At what point can options in a CSOP be exercised?
- Are there any tax benefits?
- Weighing up the advantages and disadvantages of setting up a CSOP
- How do I set up a CSOP?
What companies are eligible to set up a CSOP?
You can set up a CSOP if you’re a UK private or listed company. In certain circumstances foreign companies operating in the UK can also set up a plan, and many UK listed companies offer their management team share options. CSOPs are particularly great for unlisted, small companies, as even lower-paid employees can benefit with no need to pay for the shares until the option is exercised.
If you are a private company, you’ll need to agree your company’s value with HMRC before issuing options.
If you are considering a CSOP, there are some rules to follow, and it’s important that these are strictly observed from grant to exercise or your plan risks becoming non-tax advantaged with tax and national insurance contributions (NIC) fully payable.
The company eligibility rules in brief are that:
- Your company, which will offer its shares to employees, is either listed or fully independent i.e. not under the control of another company.
- The options are granted either by the employer or the parent company where it’s a group scheme.
- The shares subject to the option must be ordinary non-redeemable shares.
Who is eligible to participate in a CSOP?
The employee eligibility rules in brief are that:
- Employees must be employed by the company or a group company which is part of the scheme where it’s a group scheme.
- Executive full-time directors can participate in CSOPs as long as they work at least 25 hours per week as an executive director.
- Where the company issuing the shares has a limited number of owners, employees or full-time directors must not have at the time of grant, or have had in the prior 12 months, a significant stake in the company granting the options, which is a shareholding of more than 30%.
- The maximum value of shares subject to the CSOP option cannot exceed £60,000, measured at the time of grant.
What are the legislative requirements for setting up and managing a CSOP?
The first requirement when setting up a CSOP is that the shares over which options are granted must be fully paid-up, non-redeemable, ordinary shares. You must grant the options at the market value of the shares at that time. If your company is listed, you will use the mid-market closing price when you grant the option. If your company is private, you’ll need to agree the market value with HMRC. AIM companies are not treated as listed companies for this purpose. However, AIM companies should agree with HMRC their proposed approach to determining market value, in advance of the first grants under the plan.
You will then need to register the CSOP with HMRC at the latest by 6July following the tax year in which you grant the options. When you register the plan, you’ll need to self-certify that you meet the legal requirements (found in Schedule 4 of the Income Tax (Earnings and Pensions) Act 2003).
There are ongoing HMRC reporting requirements associated with CSOPs, so you’ll need to appoint someone to administer the plan year-on-year.
At what point can options in a CSOP be exercised?
When you set up a CSOP, you need to draft a set of plan rules that stipulate when the options can be exercised. You need to be careful not to inadvertently trigger the risk of an income tax/NIC liability, so you need to comply with the CSOP legislation. For example, you shouldn’t allow employees to exercise the options before three years after the grant subject to exceptions for corporate events and certain types of leavers.
You can tie the grant of options to good performance or upon the achievement of certain targets.
Options can’t be exercised more than 12 months after an employee has died.
Are there any tax benefits?
There are very useful tax benefits associated with a CSOP, such as:
- Employees will not pay income tax or NICs when the options are granted.
- They won’t pay income tax or NICs when they are exercised (provided all the legislative conditions, including the conditions below are met).
- They may pay Capital Gains Tax when they sell their shares on the appreciation in value above the exercise price (market value at the date of grant).
- The company should generally get a corporation tax deduction at exercise of the option.
The conditions are:
- The options are exercised between three and ten years from the date of the grant; or
- Within six months if the employee leaves employment because of statutory “good leaver”/involuntary scenarios; or
- Within 12 months of an employee’s death; or
- Within 6 months of a company takeover (conditions apply).
When the employee sells the shares, they will pay CGT on the difference between the exercise price and the sale price, although individuals have an annual CGT exemption.
If these conditions are not met, then the employee will pay income tax on the difference between the market value of the shares when they exercise the option, and the exercise price. They may also pay NICs.
Weighing up the advantages and disadvantages of setting up a CSOP
Advantages
- Companies that offer schemes like the CSOP have been shown to be higher performing over time.
- Unlike other share option schemes like the Enterprise Management Incentive scheme (EMI), your company doesn’t have to be operating any particular business to qualify.
- Unlike EMI there are no size restrictions so companies which outgrow EMI may implement a CSOP.
- CSOP options must generally be held for at least 3 years from grant for employees to access the tax advantages making these awards an excellent retention device.
- CSOPs are highly beneficial for employees, as they won’t pay income tax or NICs when the option is exercised (subject to the conditions described in this article).
- Employees will pay CGT on any gains, but there are preferential exemptions, rates and reliefs that may apply.
- The employer won’t pay employer NICs when the option is exercised (subject to the conditions described in this article) which offers a valuable cost saving.
- Your company may get corporation tax relief for any gain to employees, which can be a valuable tax asset on a corporate event.
- The legislative requirements associated with the CSOP have been relaxed recently which will mean the scheme will be available to more companies.
- You can agree the valuation of the underlying shares with HMRC in advance of the grant of the option which provides certainty to all parties.
Disadvantages
- Employees can only hold up to £60,000 in shares under option, unlike, say under an EMI where the limit is £250,000.
- Where you have an active EMI scheme, you need to be careful to manage the employee financial limits across both schemes as the £250,000 EMI limit effectively applies across both schemes. CSOP options must have an exercise price at least equal to the market value of the shares at grant which may be a disincentive to exercise and hold in advance of a corporate event, if employees have to self-fund a material exercise price.
- Business asset disposal relief may not apply unlike in relation to the EMI scheme.
- There are legislative requirements which must be met on an ongoing basis over the life of the CSOP option, which can make these schemes more complex to administer than non-tax-qualifying schemes.
In brief, you are most likely to benefit from a CSOP if you are a company that doesn’t qualify for an EMI scheme or has outgrown the EMI scheme.
How do I set up a CSOP?
If you're considering a CSOP, we can guide you through the tax implications, ensure compliance with employment tax rules, and help you manage reporting to HMRC to avoid penalties. We also specialise in navigating changes to employee share rights, exits, and equity sales during corporate events. Our team can help structure employee rewards in a tax-efficient way to maximise financial benefits and minimise employer National Insurance costs, which are set to rise to 15% in April 2025.
Get in touch with us today to discuss how a CSOP can work for your business and employees, and whether it's the right incentive scheme for your company. Fill out the short enquiry form below and a member of our team will be in touch shortly.
