Company share option plans (CSOPs) are tax advantaged discretionary employee share option schemes. They allow companies to issue options to any employee or full time director to buy shares.
CSOPs are available to large companies and there are no excluded trades. This is different to EMI schemes that are only available to smaller companies and not available to companies carrying out certain excluded trades (eg financial services companies).
Like all options CSOPs are used to recognise employees past achievements and incentivise them to work better for the company giving them the opportunity to gain from the company’s long-term performance.
As for EMI schemes there are tax advantages for both employees and companies but then there are conditions that the recipients of the options, the company and the scheme must comply with. We cover these and other issues below.
Tax advantages of CSOPs – individuals
When the options are exercised under a CSOP neither income tax nor National Insurance contributions (NI) are payable on the amount, if any, by which the market value at the date of exercise is greater than the exercise price. This is provided that the exercise price is not less than the market value at the date of grant and other conditions have been met.
Capital gains tax is, however, potentially payable when the shares are sold on the amount by which the sale price is greater than the exercise price. Capital gains tax is payable on the total taxable gains on all asset sales above the person’s annual exempt amount. For options where income tax was paid on exercise, capital gains tax is only payable on the difference between the sale price and the market value of the shares at the date of exercise.
It is not possible to claim business asset disposal relief (BADR) on shares received under a CSOP unlike shares received under an EMI scheme.
Tax advantages of CSOPs – companies
The tax advantages to companies are:
- National Insurance contributions are neither payable by the company when the options are granted nor when they are exercised on the difference between the current market value and exercise price, where the market value is higher
- The difference between the current market value and exercise price, where the market value is higher, is an allowable expense for the company when the options are exercised
- The costs of setting up and running the CSOP are allowable expenses for the company for corporation tax purposes.
Tax and NI advantages for options under a CSOP
Theresa exercises her 1,000 options granted to her under her employer’s CSOP scheme. The exercise price is £0.10 per share being the HMRC agreed unrestricted and restricted market value of the shares at the date of grant. The current unrestricted and restricted market value of the shares when she exercises the options is £5.00 per share.
On exercise of shares
As the exercise price was the same as the market value at the date of grant Theresa is not liable to income tax or NI on the unrealised gain of £4,900. Similarly the company is not liable to NI on this gain and can treat the gain as an allowable expense for corporation tax purposes.
If the option scheme had been an unapproved scheme then:
- Theresa would have been liable to pay tax of £1,960 (40% of £4,900) and NI of £159.25 (3.25% of £4,900).
- The company would have been liable to pay NI of £737.45 (15.05% of £4,900)
- The company would then be able to treat the NI it paid of £737.45 as an allowable expense for corporation tax purposes in addition to the gain of £4,900.
On sale of shares
Theresa then sells the shares at a later date for £7,500. She has no other taxable gains that means the whole of this is not subject to tax as it falls within her capital gains personal allowance. She has therefore not paid any tax on the excess above £100 paid on exercising the shares.
If the whole of the gain is subject to capital gains tax then, as Theresa did not pay income tax on exercising her options, £7,400 is subject to capital gains tax at 20% giving her a tax liability of £1,480. If she had paid income tax then only £2,500 would be subject to capital gains tax giving her a liability of £500. She would still have paid more tax and NI with a total liability of £2,619.25.
Requirement that a CSOP must meet
For a CSOP to qualify for the tax advantages it must meet the requirements of Chapter 8 of and Schedule 4 to the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003). These cover the individuals, shares and the terms of the share option. Looking at each of these in turn:
Eligible individuals
- Any employee of the company (or, if a group scheme, a group company) that is not a director of the company (or group company).
- Any full time director of the company (or, if a group scheme, the group companies participating in the scheme).
- Where the company is a close company or was a close company in the preceding year the individual and or their associates cannot have a material interest (ie not more than 25% of the ordinary share capital and/or voting rights of the company and/or the right to more than 25% of the company’s assets) or had such a material interest in the preceding year.
- An employee or full time director can only be granted options of up to £60,000 (from 6 April 2023, previously £30,000), including all existing unexercised CSOP options at the date of grant.
Eligible shares
- The shares must be those of:
- The company;
- The company’s holding company; or
- A company which is a member of a consortium owning the company or the company’s holding company;
- The type of share must:
- be ordinary shares;
- be fully paid;
- be non-redeemable;
- have no kinds of restrictions other than those attaching to all shares of the same class; and
- where they are of a class that requires the shareholder to be an employee or full time director of the company, that they are sold or disposed where the option holder has ceased to be such;
- The shares must be:
- listed on a recognised stock exchange; or
- in a company not under the control of another company; or
- in a company which is subject to an employee-ownership trust;
- Where the company has more than one class of share, the shares attached to the options under the CSOP must either be:
- Employee control shares – the shares of this share class give employees, directors and former employees and directors control of the company; or
- Open market shares – the majority of the shares of this share class are owned by parties that are not connected with any employees or directors.
Terms of the CSOP options
- The company must have discretion to grant options;
- The exercise price must be stated. It must be at least the market value of the shares at the date of the grant – the market value agreed with HMRC, unless the shares are listed in the Daily Official List of the London Stock Exchange when this is used to calculate the market value on the quarter up basis;
- The options must not be transferable;
- The options must not be exercisable for at least three years unless:
- Employment ceases for one of the good leaver reasons of injury, disability, redundancy or retirement. The employee would also need to exercise the options within six months of the cessation;
- The company is taken over for cash, in certain circumstances. Again, the employee would need to exercise the options within six months of the takeover; or
- The individual dies. The personal representatives need to exercise the options with one year of death;
- The options must be exercised within ten years of the date of grant.
- The terms can allow for the CSOP options to be amended to cover changes in the relevant share capital including the:
- exercise price
- number of shares
- description of the shares.
- The terms can also allow for the options to be amended where the company is taken over by another company provided that new CSOP options are equivalent to the old CSOP options. In particular:
- exercisable in the same way;
- the market values of the old and new shares at the date of the grant of the new options are the same; and
- the total amount payable on exercise is the same.
Care is required when granting CSOP options as an employee could lose the tax advantages of existing EMI options.
Reporting requirements
The company must register the CSOP with HMRC on or before 6 July following the end of the tax year in which the options were first granted. To do this the company has to give notice of the scheme to HMRC. It must confirm that the scheme meets, and has met since the first options were granted, the requirements of parts 2 to 6 of Schedule 4 to ITEPA 2003.
If the notice is made after 6 July, then the scheme is only a Schedule 4 CSOP from the tax year in which the notice is given. Therefore, any options granted in the previous tax year would be unapproved share options without the tax advantages applicable to CSOP options. However, options granted in the tax year in which the notice is given, and subsequent years, will be CSOP options.
Each year where there has been any activity (eg options granted, lapsed or exercised) under the CSOP scheme, the CSOP annual return attachment to the company’s corporation tax return needs to be completed and submitted to HMRC.
Loss of tax advantages
Care is needed to ensure that the tax advantages are not lost as there are a number of events that can cause this to happen. These include:
- Where a director, that director ceases to be a full-time director of the company and the options are not exercised within the period set by the scheme rules;
- The employee or full-time director ceases to work for the company, including by redundancy, retirement or illness and the options are not exercised within the period set by the scheme rules;
- The employee or full-time director dies and the options are not exercised within 12 months or such shorter period as provided by the scheme rules;
- Change of control – the company becomes a subsidiary of another company – and the options are not exercised within six months, unless the existing options are replaced by those in the new parent company;
- An individual becomes the owner of all or the shares of the company or all of share of the same share class as those under the CSOP and the options are not exercised within six months;
- The company’s share capital is affected by a compromise or arrangement court order and the options are not exercised within six months;
- The shares cease to meet the CSOP requirements, unless a result of a change of control or a compromise or arrangement court order when they can be exercised within 20 days of that event.
If the options are not exercised within any allowed period or are not lost, then the scheme becomes an unapproved scheme from the date of the disqualifying event. This means that all the tax advantages are lost.
The above is an overview of CSOPs provided for information only. You should take professional advice before setting up a CSOP or exercising options under a CSOP.