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. While it’s easy to give employees shares, 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 able to set up a CSOP?
- Who can 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 possibly National Insurance Contributions, provided the employee has held the option for at least three years.
What companies are able 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 great for unlisted, small companies too, 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 or your plan risks becoming non tax-advantaged with tax fully payable.
These rules in brief are that:
- Your company is either listed or fully independent
- The options are granted either by the employee or a parent company
- The shares must be ordinary shares
Who can 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 employees working more than 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 £30,000 (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 price with HMRC.
You no longer have to apply to HMRC to approve a CSOP, but you’ll need to register this with HMRC 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. You also have to agree your company’s value with HMRC if you’re not a listed company.
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 are generally free to include any rules you like, but 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, or within six months after an employee leaves your employment because they are injured, become disabled, are redundant or subject to a TUPE transfer.
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 the conditions below are met).
- They will pay Capital Gains Tax when they sell their shares.
- You will get a corporation tax deduction in relation to the grant 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)
- Within 12 months of an employee’s death
- 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 annual CGT exemptions.
If the employee doesn’t meet these conditions, then they’ll 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
- 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.
- CSOPs are highly beneficial for employees, as they don’t have to pay for the option, and won’t pay 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.
- Companies that offer schemes like CSOP have been shown to be higher performing over time.
- Employees can only hold up to £30,000 in share options, unlike, say, under an EMI where the limit is £250,000.
- You have to agree the company’s value at the time of grant.
- Entrepreneurs relief may not apply.
- If you have more than one class of shares, then special rules apply so you may be limited in the types of options you can grant.
- If your employees own more than 30% of your company, they can’t benefit from a CSOP.
In brief, you are most likely to benefit from a CSOP if you are a smaller company that doesn’t qualify for an EMI scheme, because of the kind of business you operate, or because you want to award options to part-time or lower-paid employees.