Tax-advantaged Company Share Option Plan changes: get ready!

From 6 April 2023, the requirement that only certain classes of shares can be used in a tax-advantaged Company Share Option Plan (CSOP) will be removed. This will enable more companies to consider a CSOP for the first time. Additionally, the limit on the market value of shares (measured on the date of grant) that an individual can hold under option will double to £60,000, giving CSOPs the potential to deliver more value, and a greater tax-advantaged incentive, to employees. This article sets out what companies that currently operate a CSOP need to know in advance of the financial limit changing. It also shares some thoughts on how the new CSOP regime could provide a tax-advantaged share plan as an attractive alternative, replacement, or addition to an employer’s existing incentive arrangements. In particular, companies whose growth trajectory means they have, or soon will, stop qualifying for the Enterprise Management Incentives (EMI) regime should now consider whether their next share plan should be a CSOP.

CSOPs in a nutshell

In summary, CSOPs are ‘discretionary’ share option plans (i.e. there is no requirement to offer participation to all employees) that allow individuals to acquire shares in their employer or its parent company. Provided the exercise price is at least equal to the market value of the underlying shares on the date of grant, no income tax, employee’s or employer’s NIC, or Apprenticeship Levy will arise on the exercise of a CSOP option on or after the third anniversary of its date of grant (or on earlier exercises in certain take-over and ‘good leaver’ scenarios).

Employers should also receive a statutory corporation tax deduction, when their employees exercise CSOP options, equal to any growth in value of the underlying shares since the date of grant. Broadly, employees will be subject to Capital Gains Tax (CGT) on any difference between the price paid to acquire shares on the exercise of a CSOP option and the proceeds of their sale.

What’s changing and when?

Currently, an employee cannot hold unexercised CSOP options over shares with a market value, measured on the date of grant, of more than £30,000. For some established companies, this limit reduces the effectiveness of CSOP options as an employee incentive. This limit will increase to £60,000 in respect of options granted on or after 6 April 2023.

Additionally, for companies with more than one class of shares in issue, CSOP options can currently be granted only over shares in a class the majority of which:

• Are, broadly, held other than by employees or directors (‘open market’ shares); or
• Let current and/or former employees and directors control the company (‘employee control’ shares).

These requirements have made it difficult for companies with multiple share classes, such as family companies or companies backed by one or more external investors, to grant tax-advantaged CSOP options in the past. However, also from 6 April 2023, the requirement that CSOP options be granted over either ‘open market’ or ‘employee control’ shares for multi-share class companies will be removed.

This will increase the number of companies that can implement CSOPs (though individual companies will still need to confirm that they meet all other CSOP qualifying conditions – such as not being under the control of another company).

What should companies that currently operate CSOPs do?

Based on HMRC’s current guidance, companies that already operate a CSOP should not need to amend their existing plan rules to reflect the increase in the financial limit to £60,000. This is because existing plan rules should automatically be treated as amended by the legislation that introduces the relevant changes to the CSOP regime.

Companies should nevertheless consider whether it would be appropriate to amend their CSOP plan rules to specifically reflect the updated position for new grants from 6 April 2023, to ensure that the administration of such awards is not inadvertently compromised due to out of date legacy wording in the plan documents. Companies should also consider what changes the increased financial limit might have on their grant policies (e.g. if an upcoming planned grant of non-tax-advantaged share options should be replaced in whole or in part by a CSOP grant).

What should companies that don’t currently have a CSOP consider?

We examine three scenarios below:

• CSOP as an alternative to non-tax-advantaged share incentives;
• CSOP as a replacement for an existing tax-favoured share plan (in particular, if the business currently operates a statutory tax-advantaged EMI plan but expect to ‘outgrow’ or otherwise fail to meet the EMI qualifying conditions); or
• CSOP as a new equity incentive addition to their existing employee reward offer.

CSOP as alternatives to non-tax-advantaged awards

Two common company circumstances and points to consider are summarised below.

1. Companies with non-tax-advantaged plans (including global share plans)

Multi-national groups often operate non-tax-advantaged global share plans for flexibility; but implement jurisdiction specific tax-advantaged sub-plans where local income tax and social security savings are sufficiently attractive to cover the associated implementation costs.

Global groups who have not yet implemented CSOP sub-plans for UK employees, and others who have just shunned CSOP due to the current £30,000 limit on the initial value of individual awards, should reassess the improved cost-benefit position in light of the imminent doubling of this limit and the consequential potential to deliver a more effective and efficient incentive.

2. Companies with multiple share classes

Companies with multiple share classes that don’t qualify for EMI (e.g. because they do not carry on a qualifying trade or have 250 or more full time group employees) sometimes implement ‘growth’ shares as equity incentives for key management. In summary, these are special classes of shares that can deliver geared growth in value, with gains subject to CGT not income tax.

‘Growth’ shares require management to pay market value on acquisition of their shares, or pay income tax, and potentially employee’s NIC, on any discount. Unlike an option arrangement, management also bear the full downside investment risk of being shareholders from the date of award (though this may be an important feature to best align their interests with those of investors).

Employers may also be subject to employer’s NIC and Apprenticeship Levy on any difference between the price paid and the market value of ‘growth’ shares on acquisition but – unlike with an option arrangement – cannot obtain statutory corporation tax relief for any subsequent growth in value.

Multi-share class companies that will qualify for CSOP from 6 April, but which will not qualify for EMI, should consider whether a CSOP would offer an attractive alternative to a direct acquisition of ‘growth’ shares – either with CSOP options over an ordinary share class, or over the ‘growth’ shares.

This could allow management to acquire share incentives without any upfront investment and/or income tax and social security cost. A CSOP could also enhance company value on an exit by delivering statutory corporation tax relief on any growth in value. However, companies would need to assess whether the different risk profile for management, and the possibility that in some circumstances income tax relief would not be available on the exercise of a CSOP option on an exit within three years of the date of grant, would meet their commercial requirements.

Due to the complexity of managing forfeiture of ‘growth’ shares from leavers, such arrangements are often confined to the executive leadership team only. The administration of option lapses for leavers is far simpler and therefore the ability to use CSOP might enable an employer to be more inclusive and grant awards tax-efficiently to a wider population.

CSOP as a replacement for exhausted EMI

EMI plans offer the most flexible and generous tax-advantaged UK share options. But their availability is subject to qualifying conditions that companies can ‘outgrow’ (e.g. by employing their 250^th full time employee). Removal of the share class requirements will make CSOP available to more companies that cease to qualify for EMI – offering a potentially viable statutory tax-advantaged option successor to EMI for the first time – and the doubling of the CSOP financial limit will reduce the gap between EMI and the next best tax-advantaged alternative.

Companies that no longer qualify for EMI, or expect to cease to qualify soon, should consider whether the new CSOP regime would be preferable for future grants, rather than, for example, ‘growth’ shares or non-tax-advantaged options. For formerly EMI qualifying companies that choose to move to CSOP, specific professional advice should be taken on implementation and option grants as, in certain circumstances, granting CSOP options could disqualify an individual’s existing EMI options.

CSOP as an addition to your employee value proposition

Established family-owned businesses are often too large (in terms of both employee numbers and balance sheet assets) to operate EMI and would not usually want to grant options to employees over the same class of shares as are owned by the family owner-manager shareholders. The incoming changes mean that CSOP grants could be made over a new class of non-voting share with differing rights and enhanced restrictions – thus providing protection for the family whilst delivering a tax-efficient equity reward to employees, linked to sustainable value creation and a minimum three years’ service post grant. Any concern about lack of liquidity in terms of realisation of value might be overcome using an employee share ownership trust.

CSOP grants can only be made to full-time directors but there is no minimum working time for employees. It’s important to bear in mind that, as well as presenting a tax-advantaged alternative or replacement share plan, companies can operate CSOPs in conjunction with other tax-advantaged plans (such as SAYE or ‘sharesave’) plans, as well as ‘top up’ non-tax advantaged arrangements.

How KPMG can help

We have extensive experience advising companies on the design, implementation, and operation of all types of employee share plan and bespoke senior executive incentives. Please contact the authors below, or your usual KPMG contact, to talk through what opportunities the new CSOP regime could present for your business.

For further information please contact:

• Liz Hunter

• Chris Read