Why Should Your Company Have CSOPs (Company Share Option Plans)?
CSOPs are tax-advantaged arrangements where a company can grant share options to employees and full-time directors for acquiring shares in a company at a future date for a pre-determined price. Although not quite as tax efficient as Enterprise Management Incentive (EMI) option schemes, CSOPs may still serve as a good alternative for companies that do not satisfy the qualification criteria for EMIs.
Why should a company adopt CSOPs?
1. CSOPs offer tax reliefs for both the employee and the company (see below).
2. CSOPs are discretionary in nature – this allows the company to decide:
- which employees to receive options;
- value of the awards; and
- any other specific conditions they wish to impose before the employee can exercise the options.
The company can offer personalised terms to different individuals, rather than on an employee-wide scale.
3. Alongside no upfront cost, employees have no obligation to exercise the CSOP options and can let them lapse without incurring any financial obligation.
4. CSOPs should be particularly attractive to companies that cannot grant EMI options. The conditions that a company must satisfy to be able to grant CSOP options are less restrictive than those attached to EMI options.
5. Following 6 April 2023:
- The maximum limit an employee can hold in CSOP options doubled from £30,000 to £60,000 – previously, due to the relatively low limit, CSOPs were only attractive to companies that wanted to make small awards to a large number of employees. Companies can now make large awards to key employees under CSOPs.
- Companies can now grant CSOP options over any class of shares (including growth shares) – this may mean that companies with different share classes are now able to grant CSOP options.
6. Companies can also grant CSOP options in conjunction with other non-qualifying CSOP options.
7. There are no restrictions on the trade of the company, in order to be able to grant CSOP options.
What are the tax implications?
1. Generally, there is no income tax or National Insurance contributions (NICs) payable on the grant date. However, an income tax charge may arise where the pre-determined exercise price is less than the market value on the grant date.
2. In addition, no income tax or NIC will be payable on the exercise date provided that certain conditions are met:
- The option is exercised within 10 years of the grant date and at least 3 years after the grant date; or,
- The option is exercised within 3 years from the grant date in the following circumstances:
– Within 6 months of cessation of employment for a ‘good leaver’ (e.g. injury, disability, redundancy, or retirement); or,
– By the employee’s personal representative within 12 months of death.
If these conditions are not met, income tax will be due on any increase in value between the pre-determined exercise price and the market value of the shares on the date the option is exercised. This may be collected under PAYE, in which case NICs will also apply.
3. If and when the employee chooses to dispose of the shares after exercising the option, capital gains tax (CGT) will be payable on any increase in the value of the shares between the pre-determined exercise price and the disposal price. Individuals benefit from a CGT annual exemption (£6,000 for 2023/24) and further gains are subject to CGT at 20% for higher-rate income earners (or 10% if below the threshold of £50,271 for 2023/24).
4. Generally, the company granting the option qualifies for a deduction in corporation tax for the accounting period in which the option is exercised. The deduction is equal to the difference between the pre-determined exercise price and the market value of the shares on the date of exercise.
What are the conditions?
1. The company must either be:
- Listed on a recognised stock exchange (or if unlisted, must not be the subsidiary of a listed parent company); or
- Independent and not controlled by another company.
The company can be based outside the UK and no trade is excluded from qualifying for the scheme.
2. Generally, the options may be granted to any employee or any full-time director (working at least 25 hours a week). However, individuals with a material interest in the company (broadly speaking, over 30% equity interest) are not eligible to be granted CSOP options.
3. The maximum an employee may hold in CSOP options is £60,000. This is calculated using the market value of the shares on the grant date. CSOP options must be granted at a pre-determined exercise price equal to or exceeding the market value of the shares on the grant date.
4. CSOPs need to be registered with HMRC on or before 6 July following the tax year in which the options were granted. On registration, the company must declare that the CSOP meets the conditions detailed in the CSOP legislation.
In addition to the main conditions above:
- The options cannot be transferred (other than to a personal representative);
- The options must lapse within 12 months of death;
- It must be clear that the option is a right to acquire shares;
- The options must be granted using an option agreement that complies with the CSOP legislation; and
- The option plan must provide benefits in the form of shares or options.
CSOPs in practice
Broadly speaking, three types of companies that should be most suitable for considering CSOPs:
1. UK private companies
CSOPs are usually relevant for private companies where the company does not satisfy EMI requirements.
2. UK listed companies
Many listed companies already have discretionary option plans which can be made more attractive by structuring the option plans so that the first £60,000 worth of shares qualify as CSOP options that can benefit from the tax reliefs.
3. Foreign companies extending option plans to the UK
Foreign companies often wish to grant options to their UK employees whilst granting other options to other employees. It is possible to draft the overseas option plan so that it qualifies for tax relief as a CSOP. This means that options can be granted to their UK employees within the £60,000 limit that qualifies as CSOP options. Options granted in excess of this limit can be granted under the overseas option plan as non-CSOP options.
However, if a foreign company satisfies the qualification criteria to offer EMI options, it should grant EMI options rather than CSOP options as EMI options are more tax efficient.
CSOPs and Growth Shares
Due to the recent change to CSOP legislation allowing companies to grant CSOP options over any class of shares, UK private companies that do not satisfy the EMI conditions may wish to consider granting CSOP options over growth shares. This is possible where a company has growth shares as a class of shares or where it is able to amend its articles of association to create them.
Growth shares are a class of shares that only allow the holder to participate in the value of the company once the company has grown in value above a pre-determined hurdle. For example, if a company is worth £5m today, the hurdle could be set at £8m, meaning that an employee will not benefit from the value of the shares until the company reaches the valuation hurdle. Since it is possible that the company will not achieve the growth required to benefit from the growth shares, the shares can have a relatively low acquisition value compared to ordinary shares. This is a more affordable method for employees to invest in the company.
The ability to grant CSOP options over growth shares further reduces the potential risk for employees, while increasing the likely return. This is because there is no upfront cost to the employee, and the pre-determined exercise price will be relatively low compared to the return for the employee. There is also an administrative benefit to this hybrid CSOP/growth share scheme as no shares are transferred on the grant date so if an employee were to leave before the valuation hurdle is reached, the options will simply lapse.
The worked example below shows how the tax reliefs that CSOPs offer can be used to incentivise and benefit employees.
Three years ago, Company A granted a CSOP option to one of its employees, which allows the employee to acquire 10,000 shares at the price of £5 per share (being the market value at the time of grant).
After three years’ time, today the market value of Company A’s share has increased to £20 per share. The employee decides to exercise the option, paying £50,000 for the shares that are now worth £200,000.
As this is a CSOP option, and three years have passed before the employee exercised the option, no income tax or National Insurance contributions will be charged on the £150,000 difference between the pre-determined price and the current market value of the shares when the option is exercised. However, if the employee sells the shares (either immediately or in the future), capital gains tax on any gain made up to the point of sale will be chargeable.
How we can help
Here at The Jonathan Lea Network, we have significant experience and expertise with matters involving share incentive schemes like CSOPs. We are happy to utilise our skills and expertise to resolve common and uncommon issues that may arise during the process.
If you would like to know more about CSOPs and whether your company should adopt CSOPs, we offer a no-cost, no-obligation 20-minute introductory call as a starting point. Please email email@example.com providing us with any relevant information ensuring that any call we have is as productive as possible. After this call, we can then email you a scope of work, fee estimate, and confirmation of any other points or information mentioned on the call.
This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited 2023.