We provide advice on the implementation of share option schemes, usually in the context of our advice in rewarding key management and employees and also as part of the wider consideration in business succession planning.

The choice of scheme will depend on a number of factors, including the objectives behind it, the business itself (business sector, number of employees, value etc.) and the number and range of employees to be involved.  There are also different tax consequences and financial limits for each. 

These are popular schemes but require careful thought and advice and a degree of planning prior to implementation.

In order to avoid income tax arising for employees, the company would require to be valued, the valuation should be agreed with HMRC and the options granted at this value (i.e. the exercise price should equal the share value). Any discount to valuation would attract income tax.

There is likely also to be Capital Gains Tax (CGT) on a sale after the options have been exercised but Entrepreneurs Relief may be available.

There are conditions which both the granter (Company) and grantee (Employee) require to meet. The following list is not exhaustive but includes:

  • The gross assets of the Company must not exceed £30m;
  • The number of FTE employees must not exceed 250;
  • Certain business activities are excluded such as care homes, property development, dealing in land, farming woodlands and hotels;
  • The individual grant limit must not exceed £250,000 per employee;
  • The employee must work at least 25 hours per week for the Company/75% of their working time; and
  • The shares require to be ordinary, voting shares.

From the Company and the other shareholder’s perspective, there are some key legal issues to consider before the options are put in place:

  • A power of attorney may be beneficial if there is a contemplated sale of the Company.
  • A shareholders agreement should be put in place with detailed consideration given to matters such as good leaver/bad leaver and Drag along/Tag Along provisions as well as pre-emptions on transfer.

Company Share Option Plans (CSOP) are tax-advantaged options which are typically used by companies that do not qualify to grant enterprise management incentives (EMI) options.

The company that establishes the scheme must certify that it meets the statutory tests.

HMRC may carry out a compliance check to make sure that CSOP options comply with the CSOP code.

General requirements for a CSOP

Purpose test

The legislation includes a requirement that the purpose of a CSOP must be to provide benefits to directors and employees in the form of share options. A CSOP must not provide any other form of benefit. In particular, the CSOP must not provide any cash alternative to either shares or options.

The individual limit on unexercised options

An employee may only hold CSOP options over shares with a value up to £30,000 in respect of employment with a particular company or group of companies. For this purpose, the shares are valued at the time of grant.

Value

The option exercise price must not be less than the value at the date of grant, any discount would be taxable.

Qualifying conditions for companies

There are complex statutory rules for which companies can establish a CSOP.

Employees

Employees must work “full time” for the company with a minimum of 25 hours per week.

An SAYE option scheme is a type of tax-advantaged share scheme. It is also known as a share save scheme, save as you earn option scheme or savings related share option scheme.

It provides for the grant of share options. The exercise price can be set at up to a 20% discount to the market value at the time of grant. Participation must be available to all employees, subject to a qualifying period of service which cannot be more than five years (and other employees may also be included). The grant of the option is conditional on the employee taking out a linked savings arrangement with a bank or building society to save up the option exercise price.

At the end of the savings period, the employees either use the money saved to exercise their option and buy shares, or withdraw their savings.

As with any share option, an SAYE option is risk-free for the employee, in that there is no future obligation to exercise the option. The employee does have to commit to regular savings, but the savings contract can be cashed in at any time.

The savings contract

The grant of an SAYE option is conditional on the employee entering into an HMRC-certified savings arrangement. This will require the employee to save between £5 and £500 per month for three or five years generally by deduction from pay (after tax).

A number of the large banks and financial institutions have specialist teams that set up and operate these savings arrangements on behalf of employers.

At the end of the savings period, the accumulated savings can be withdrawn. Savings contracts taken out on certain dates have a tax-free bonus equal to a guaranteed number of monthly contributions.

Qualifying Companies

There are complex statutory provisions governing which companies are permitted to adopt an SAYE option scheme and the shares that can be used.

In summary:

  • The company whose shares are placed under option must be either listed on a recognised stock exchange or free from the control of another company, unless that other company is itself listed on a recognised stock exchange.
  • The options can be granted either by the employer or a parent company.
  • The shares under option must be ordinary share capital.

Who can participate in an SAYE option scheme?

SAYE option schemes are all-employee schemes, meaning that all eligible UK-resident employees and full-time directors must be invited to participate in an offer made under an SAYE option scheme. A qualifying period of service may be imposed, but this cannot be more than five years (see Practice note, Age discrimination and employee share schemes).

Invitations to join a scheme are often made on an annual basis, although this is not a legislative requirement. The rules of an SAYE option scheme may be drafted to allow the following additional employees to take part in the scheme:

  • Non-resident employees and full-time directors.
  • Employees and full-time directors with a qualifying period of service that is less than the period specified in the scheme.

Setting the exercise price and valuing the shares

The exercise price must be fixed when the option is granted and may not be less than 80% of the market value of the shares at or shortly before the date of invitation to participate.

If the shares are not quoted on a recognised stock exchange, the market value of the shares must be agreed in advance with HMRC.

Tax treatment for the employee

The key tax issues for an employee holding an SAYE option is as follows:

  • On grant – There is no income tax liability on the grant of the option.
  • At the end of the savings period – Any savings bonus or, if the savings arrangement is terminated early, any interest payable, is not subject to tax.
  • On exercise – There is no income tax liability on the exercise of an SAYE option if the date of exercise is at least three years after the grant date.

Share incentive plans (SIPs) are a type of tax-advantaged all-employee share plan. They enable companies to invite eligible employees to acquire shares in the company which are then held in a special employee benefit trust (EBT).

Share incentive plans are likely to be suitable for larger, probably listed, companies. They can be more expensive to set up and administer than other types of share plans, but if communicated appropriately, can be successful and popular with employees.

The shares used for a SIP must be in a company that is one of the following:

  • Independent.
  • Listed on a recognised stock exchange.
  • Under the control of company listed on a recognised stock exchange.
  • Subject to an employee-ownership trust (as defined in paragraph 27(4)-(6), Schedule 2).
  • The shares must be ordinary shares that are fully paid up and are not redeemable.

Tax and NICs treatment for the employee

Free and matching shares

Awards of free and matching shares are not subject to income tax at the time of award

Partnership shares

Income tax and class 1 NICs are not payable on the amount which is deducted from an employee’s pay to purchase partnership shares

Dividend shares

Cash dividends reinvested in dividend shares are exempt from income tax (although the employee is not entitled to any associated tax credit)

CGT on disposal of shares

Any growth in value of SIP shares is sheltered from CGT while the shares remain held in the SIP trust under the rules of the SIP. If shares are sold directly from the SIP, no CGT will arise. If shares are withdrawn from the SIP trust, and later sold, then CGT may be payable on any gain over their value when they came out of the SIP.

Annual returns

Companies operating a SIP must file an annual return using the ERS online service by 6 July following the end of each tax year. Penalties may apply if forms are completed incorrectly or not filed on time.

Summary

As can be seen, the choice of share option route to follow is complex and driven by restrictions around qualifying conditions, tax implications and commercial drivers with the result that detailed advice should be obtained before settling on the correct form of share option.

To discuss this further, contact one of our Business Law specialists today.

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