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 should you take the plunge?
- What is a company share option plan (CSOP)?
- 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
What is a company share option plan (CSOP)?
Under a company share option plan or CSOP, you can grant options to any employee or director of your company at the market price of the shares at the time of the grant. Any gain made from the shares is exempt from income tax and National Insurance Contributions, provided the employee has held the option for at least three years.
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 fully payable.
The company eligibility rules in brief are that:
- Your company is either listed or fully independent
- The options are granted either by the employer or the parent company
- The shares subject to the option must be ordinary shares
Who is eligible to participate in a CSOP?
Any employee (part-time or full-time) or full-time director can be awarded options in a CSOP, however if your company has a limited number of owners, you can’t grant options to someone who has a major stake in the business (30% or more). HMRC deem directors working at least 25 hours every week as ‘full-time’.
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 can only grant options worth up to £60,000 (market value at the time of grant) to any one employee. 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 6th July 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 trigger the risk of a tax 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 National Insurance Contributions (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 (see above); 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
- 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
- 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)
- Employee will pay CGT on any gains, but there are preferential exemptions, rates and reliefs that may apply
- 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
- 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.
- 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.