In its Autumn Statement, the UK government confirmed that it would go ahead with changes to company share option plans (CSOP) that were announced in September's mini-Budget. From April 2023, the CSOP limit will double to £60,000 and share class restrictions will be relaxed. Whilst CSOP is a UK tax-advantaged option plan, like enterprise management incentives (EMI), CSOP options can generally only be exercised income tax free after three years and the increased limit remains considerably lower than EMI. Nevertheless, these changes widen access to companies who have outgrown EMI but are currently prevented from operating a CSOP, including venture-capital backed companies and others with multiple share classes.
Earlier this year, the government announced it was considering reforming the CSOP, to support companies as they outgrow the scope of EMI. After much lobbying by industry, CSOP reforms were finally announced in September’s mini-Budget and confirmed in November's Autumn Statement (being one of the few measures to have escaped being scrapped!).
The government proposes to double the CSOP limit to £60,000 and relax the current CSOP share class restrictions.
These changes will be of particular interest to growth companies who do not qualify for EMI, such as those who have outgrown the EMI employee limit and gross assets test but are currently prevented from operating a CSOP due to the restrictions on share classes, including venture-capital backed companies and others with multiple share classes.
It could be time for companies to reconsider CSOP options as part of their remuneration and incentive architecture if they are not currently offered. Although the changes are not set to come in until April 2023, companies may need time to socialise the idea internally and agree a share valuation with the UK tax authority (HMRC) in advance of any grant, so some companies are starting to look at this now.
Two key changes for the CSOP regime were announced in the mini-Budget:
Whilst the increased limit of £60,000 will remain considerably lower than the EMI limit of £250,000, it is clearly a step in the right direction. However, there has been no mention of relaxing the current restriction on granting CSOP options where the EMI limit has been reached, so the aggregate individual limit looks set to remain at £250,000.
Removal of restrictions on share classes: The government has announced that, also from 6 April 2023, it will ease certain ‘worth having’ restrictions on share classes. For companies with more than one class of share, the majority of the shares of the class used for a CSOP must be either ‘employee-control shares’ or ‘open market shares’. See ‘Key requirements’ below for details.
The share class restrictions can prevent venture-capital backed companies and others with multiple share classes from operating a CSOP so, particularly for those who do not qualify for EMI, the removal of the restrictions will be welcome news.
A CSOP is a type of discretionary share option plan which is eligible for tax favourable treatment in the UK, provided it has been registered with HMRC and meets certain legislative requirements.
CSOP options can be used to incentivise directors and employees to grow the company, by giving them the right to buy shares in the future if they pay a price equal to the value of the shares at the outset.
On the exercise of a CSOP option, the shares may be acquired free of income tax and National Insurance Contributions (NICs), provided the option continues to meet the necessary requirements and is exercised in accordance with the legislation. Any gain above the option exercise price will normally be subject to capital gains tax on disposal of the shares. See ‘Tax benefits’ below.
Broadly speaking, a company’s shares are ‘employee-control shares’ if they are held by employees or directors who together control the company. The shares are ‘open market shares’ if they were not acquired as a result of a right or opportunity as directors or employees (unless it was as a result of an offer to the public), or by trustees on behalf of any such persons.
The above summarises the key requirements only (as at the time of writing). A number of other requirements apply in relation to the establishment and operation of a CSOP.
CSOP options can benefit from significant income tax and NICs breaks, both for the company and the director or employee.
On the exercise of a non tax-favoured option, the difference between the market value of the shares on acquisition and the option exercise price would normally be chargeable to income tax (and employee and employer NICs, where the shares qualify as readily convertible assets).
However, a CSOP option may be exercised free of income tax (and any employee or employer NICs), provided it continues to meet the necessary requirements and is exercised in accordance with the legislation.
Provided the CSOP option is exercised on or after the third anniversary of the date of grant and no later than the tenth anniversary of grant, and in accordance with the CSOP requirements, the exercise of the option will be free of income tax (and any employee or employer NICs).
The exercise of options before the third anniversary of grant may also be free of income tax (and any NICs) on leaving employment in certain circumstances. Those include exercise within six months of leaving due to injury, disability, redundancy, retirement, sale of the employing company or certain transfers of a business out of the group, or exercise by personal representatives up to 12 months after death. Exercise in connection with certain cash takeovers and similar corporate events will also be free of income tax (and any NICs).
Capital gains tax is normally payable when shares acquired on option exercise are subsequently disposed of, subject to any available reliefs and tax-free allowance. For CSOP options exercised income tax free, the taxable gain would be based on the difference between the disposal proceeds and the option price.
EMI plans are targeted at small trading companies, with gross assets of £30 million or less and fewer than 250 employees, amongst other qualifying conditions. Companies who are larger than this, or who otherwise do not qualify for EMI for example due to undertaking excluded financial services activities, will need to consider other types of incentive arrangement to incentivise and reward their people. Whilst CSOPs may not have been available to many of these companies, that is now set to change.
The table below highlights some of the similarities and differences between CSOP and EMI options.
|Discretionary or all employee plan||Discretionary||Discretionary|
|Tax treatment of exercise of options granted at a market value exercise price||No income tax or NICs||No income tax or NICs|
|Minimum period for tax-free exercise||3 years (subject to exceptions)||No minimum holding period|
|Limit on value of shares that can be held by individual under unexercised options||£30,000 increasing to £60,000 in April 2023||£250,000|
|Limit on value of shares under options that company can grant||No limit||£3 million|
Generally speaking, once a company qualifies for EMI it is more flexible than a CSOP. For example, as well as the three-year rule for tax-free exercise and limited exceptions to this, CSOP options must be granted at a price which is not manifestly less than the market value of the shares at grant. Whereas for EMI options, there is no equivalent three-year rule and the exercise price can be set at any value (if it is set at or above market value, it allows for full tax relief but there is nothing to stop companies from setting the exercise price below this value).
In addition, business asset disposal relief (BADR) is more readily available for EMI options. Where BADR applies, gains are taxed at a flat rate of 10%, rather than the current 10% and 20% capital gains tax rates. Ordinarily for BADR to apply, certain conditions need to be met, including trading, employment and holding period requirements. However, unlike for CSOP options, for EMI options the option period from grant counts towards the two-year holding period requirement and the usual 5% shareholding, voting rights and economic interest requirements for BADR do not need to be met.
For these reasons, EMI options are likely to remain the first choice where companies qualify for that regime, but the changes now also position CSOPs as a viable alternative where they previously may not have been.
Companies who have outgrown EMI or otherwise do not qualify for EMI may currently be prevented from operating a CSOP due to the share restriction requirements.
The reforms announced in the mini-Budget provide a fresh opportunity for companies to consider CSOP options as of April 2023 and, with the CSOP limit also doubling to £60,000, growth companies which are currently unable to operate a CSOP (and others who have dismissed CSOPs in the past) should now ensure these are on their radar.
If you would like to discuss the impact of these proposals, please contact a member of the Incentives team or your usual Taylor Wessing contact.
A different version of this article was first published on Tax Journal on 7 November 2022.