CSOP (the Company Share Option Plan) – given an April boost by the Chancellor

What’s the benefit? - A CSOP enables a company to grant share options to selected directors and employees over shares at a market value agreed with HMRC at grant date. The acquisition of shares on the exercise of the option three or more years after the date of the grant will be free of income tax and National Insurance, and only capital gains tax is payable on a sale of the shares. This means the employee pays 10% or 20% CGT on gains, rather than up to 60% in PAYE and NI.

When will a CSOP be appropriate?

A CSOP is a discretionary plan, which means that companies can select particular executive directors or employees to benefit, rather than an all-employee plan such as the approved share incentive plan (SIP) or Save As You Earn, where all eligible employees and directors must be invited to participate. An individual can hold CSOP options over shares with a value of up to £60,000 as at the date of grant of the options. It's important to note that this amount is calculated using the HMRC-agreed market value, which for employees will typically be heavily discounted, such that the £60,000 limit can be worth several times that amount in real market value.

Which companies can use a CSOP?

To qualify to grant a tax-favoured option under a CSOP, a company must be independent and not controlled by another company (i.e. not a subsidiary). There are no exclusions based on trading activity – any business type is eligible. This makes CSOP a good alternative to EMI share options which have a number of excluded activities such as hotels and care homes, financial services, and legal and accounting services.

Who can be granted an option?

Any employee is eligible, but only directors working at least 25 hours a week for the company are eligible – non-executive directors cannot participate. There is no working time requirement for employees who are not directors. Individuals with more than a 30% shareholding already are also unable to participate.

Requirements for the options themselves

Share options must be granted with an exercise price which is equal to or exceeds the market value of a share at the grant date. The options, therefore, provide a benefit to participants to the extent that the value of the shares increases between the date of the grant and the date the employee exercises that share option. That growth in value is delivered income tax free under a CSOP within the £60,000 maximum limit and assuming all other conditions are met.

When can an option be exercised?

In order to benefit from the favourable tax treatment offered by a CSOP, the option should not be exercised less than three years from the date of the grant except in certain circumstances set out below. You can make the options subject to specified performance targets, which should be clearly laid out by the company at the date of the grant and communicated to option holders.

Early exercise of a share option (ie within 3 years from the date of the grant) may benefit from the tax-favoured status in the following circumstances:

• "good leavers" – disability, injury, retirement or redundancy (if exercised within 6 months)
• death (if exercised within 12 months)
• certain "company events" - a cash takeover of the company, a court-sanctioned scheme of arrangement

Tax treatment

For individuals exercising CSOP options in approved circumstances, the big advantage of the scheme is that any increase in the value of the shares between the grant and the exercise of the share option is delivered free of income tax and NICs. If and when the shares are sold by the employee, normal capital gains tax (CGT) rules will apply to any gains in value, so tax will be payable at the 10% or 20% rate for CGT and the annual allowance will be available as well. Share options should not be exercised within 3 years of the date of grant other than in the specified circumstances above, otherwise income tax and possibly NICs (rather than CGT) will be due on any increase in value over the exercise price. This could be very expensive if you consider that the liability could be up to 60% in tax.

The company itself is likely to qualify for a corporation tax deduction when the option is exercised by its employees. Tax relief is given as a deduction from company profits of an amount equivalent to the benefit received by the option holder.

How is the CSOP operated?

A separate signed option agreement will be required for each employee. This enables the company to tailor each grant of an option to the particular employee. It’s fine to have different vesting periods and option numbers for different employees.