CSOP: The three-year rule explained

Last updated: 19 April 2024

Congratulations! Your employer wants to award you share options under their Company Share Option Plan (CSOP).

While the scheme gives you the chance to purchase company shares at a predetermined price, you want to time it just right. 

The three-year rule works as a guiding principle, offering a window of opportunity for maximising tax benefits and unlocking the full potential of CSOPs.

If you’re wondering what the three years are all about, keep reading.

What’s the three-year rule for CSOP?

If there is a scenario any company wants to avoid, it is employees acquiring shares and then leaving shortly after. The three-year rule exists precisely to avoid this by encouraging employees to stay for at least that long to reap the tax benefits of the scheme.

Generally speaking, in the UK, employees don’t owe any tax upfront when a company grants them options. But when exercising or selling them, it's a different story.

Exercise = Convert options into real shares by paying the exercise price.

However, if you wait three years after the grant date to exercise your CSOP options, you won’t pay Income Tax or National Insurance. Capital Gains Tax is due on sale but the good news is that everybody has a tax-free CGT allowance. 

If you exercise your options before the three-year mark, you may still be eligible for tax breaks depending on the circumstances (which we'll come onto).

The three-year rule is the key to unlocking tax efficiency. So it makes sense for the vesting period to align with this timeframe.

Vesting = A vesting schedule determines how and when somebody earns their options.

By adhering to HMRC regulations and leveraging the tax advantages afforded by the three-year rule, businesses can create a win-win scenario - saving employees money, increasing participation and improving retention. 

That’s great, but what if I have to leave?

You don’t always get to decide when you’re going to leave a business. You may suffer from injury or some other illness; you may be made redundant or reach pensionable age before the three years are up.

These are considered good reasons to leave the business, and they would make you what we at Vestd call a “good leaver”. 

Good leavers can keep any vested options as long as the option is exercised within six months from the end of employment and as long as the option agreement specifies tax benefit exemptions such as this (which our CSOP agreements do).

This would be good news for someone who is already dealing with serious issues such as being made redundant or suffering from an injury or illness (we are very, very hopeful that won’t be your case!). 

It's worth mentioning that other factors can impact when and under what circumstances you can actually exercise your options, as CSOPs can be conditional. In other words, there may be time or performance-based conditions you must meet too. 

How much time do I have to exercise my options?

The tax benefits kick in three years after the grant date and have a ‘shelf life’ of ten years. After that, the options lose their tax-advantaged status. So, exercise your options too early and you might miss out, leave it too late and you will miss out.

Learn more about CSOPs

With CSOPs, timing is everything. To enjoy the maximum possible upside, exercise your options within three to ten years following the grant date. And if you want to know more about this tax-friendly option plan, download our free guide.

If you think your employer might be interested in setting up a CSOP, why not point them in our direction? We offer free, no-obligation consultations.