Understanding the CSOP: A Guide to Tax-Qualified Discretionary Share Option Plans

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Introduction

In the realm of employee benefits and incentives, the Company Share Option Plan (CSOP) stands as an attractive option. It’s a tax-qualified discretionary share option plan that enables companies to grant their employees and full-time directors the opportunity to acquire company shares at a predetermined exercise price, typically set at or above the market value of the shares on the grant date. What makes CSOP particularly appealing is the range of tax reliefs it offers, making it a win-win for both companies and employees.

Tax Reliefs

The tax advantages associated with CSOPs are indeed generous:

  1. No Income Tax or Social Security on Grant: When CSOP options are granted, neither the employee nor the company is liable for income tax or social security contributions.
  2. No Income Tax or Social Security on Exercise: Assuming certain conditions are met, there is no income tax or social security payable when the CSOP options are exercised.
  3. Capital Gains Tax on Sale: Gains made from selling the option shares are subject to Capital Gains Tax (CGT) with no minimum holding period required.
  4. Corporation Tax Deduction: Companies can generally qualify for a corporation tax deduction equal to the spread (the difference between the market value of the option shares on the date of exercise and the exercise price) for the accounting period in which the option is exercised, even if participants are relieved from income tax.

To qualify for these tax benefits, CSOP options must be exercised within 10 years of the grant, and certain conditions must be met. These conditions include exercising the option at least three years after the grant date or within six months of leaving employment for specific reasons, such as injury, disability, redundancy, retirement, or company transfer. Additionally, the participant’s personal representatives can exercise the option within 12 months of their death, or within six months of specific cash takeovers.

Flexibility:

CSOPs offer a high degree of flexibility in structuring the option terms. While there are minimal requirements under the CSOP legislation, the options cannot be transferred except to personal representatives. They must also lapse within 12 months of an individual’s death and must clearly represent a right to acquire shares. The purpose of the plan should align with providing benefits in the form of shares or options in accordance with the legislation.

Companies often structure CSOPs to minimise the chances of options being exercised in circumstances that would trigger income tax and National Insurance Contributions (NIC) liability. For example, options may be designed to be exercised only after three years or within six months in good leaver situations.

Conditions:

To qualify for tax advantages, a CSOP must meet specific requirements, including:

  • Eligibility of individuals to participate.
  • Limits on the value of shares an individual may hold under CSOP options.
  • The type of shares that may be subject to option.
  • Self-certification procedures.

Eligible Employees:

CSOP options can be granted on a discretionary basis to any employee or full-time director of the company or its constituent companies in the case of a group plan. However, if the establishing company is a close company, participants become ineligible if they have a “material interest” in the company, generally defined as a substantial ownership stake.

Individual Limit and Exercise Plans:

The maximum value of shares an individual can hold under CSOP options increased from £30,000 to £60,000 on April 5, 2023. The limit is based on the market value of the shares on the grant date. Furthermore, restrictions on the type of shares that can be used were also removed, allowing greater flexibility in granting CSOP options.

Plan Shares:

Plan shares must be fully paid up, non-redeemable, ordinary shares. They can belong to an independent company or be listed on a recognised stock exchange. The requirements around the class of shares have been simplified since April 5, 2023, allowing options over specially created “growth shares” to extend the individual limit of £60,000.

Self-Certification:

The CSOP application process was simplified on April 5, 2014, with the introduction of self-certification. CSOPs no longer require formal approval from HMRC but must be registered by July 6 following the tax year in which options are first granted. This process streamlines the establishment of CSOPs.

CSOPs in Practice:

CSOPs are popular among three types of companies:

  • UK Listed Companies: Most listed companies can structure their options to make the first £60,000 worth of shares qualify as CSOP options. This can be especially beneficial for lower-paid employees, allowing them to benefit from future growth without a cash cost.
  • US Companies Extending Plans to the UK: US companies can draft sub-plans to their existing schemes to qualify for CSOP tax relief, enabling UK employees to receive options within the £60,000 limit.
  • UK Private Companies: Private companies not eligible for more generous tax-relief schemes may find CSOPs to be an attractive option. This is especially true if they have growth shares, as CSOPs offer tax advantages and simplified handling of leavers.

While CSOPs offer significant advantages, there are potential income tax charges if options are exercised within three years without qualifying for tax relief. It’s essential to work closely with HMRC to ensure the valuation of option shares aligns with the company’s goals.

Conclusion: 

The Company Share Option Plan (CSOP) is a valuable tool for companies looking to incentivize their employees through share options while enjoying substantial tax reliefs. Its flexibility and generous benefits make it a compelling choice for businesses of various sizes and structures. However, careful planning and adherence to regulations are essential to maximise the advantages of CSOPs.