CSOPs explained

Last updated: 25th October 2023

Company share option plans (CSOPs) are tax-advantaged schemes for businesses seeking to empower their employees (or full-time directors) by giving them skin in the game.

CSOPs benefit from excellent tax exemptions from Income Tax and National Insurance for recipients upon grant and exercise, providing certain rules are adhered to. 

And unlike the Enterprise Management Incentive (EMI), CSOPs aren’t limited to companies of a specific size. 

Plus, the government doubled the maximum value of CSOP options a person may hold from £30,000 to £60,000 in April 2023, as well as relaxing rules on the class of shares that can be granted – so it’s a great time to consider this flexible scheme. 

CSOP: the flexible, retention-boosting, tax-efficient benefit.

Contents

1. What is a CSOP?
2. What is the eligibility criteria for CSOPs?
3. What are the benefits of CSOPs?
4. How does a CSOP work?
5. CSOP tax treatment
6. What happens to an employee’s CSOP options if they leave?
7. What's the difference between CSOP and other share option schemes?
8. How to set up a CSOP?
9. Further reading and resources

What is a CSOP?

A CSOP is a share options scheme authorised by HMRC, allowing UK companies to grant employees the option to purchase company shares at a predetermined price.

The barebones:

1. At the start of the scheme, the company sets a fixed "option price" for its shares set at the market value at the time. This means that employees are given the chance to buy (exercise) the company's shares at this price in the future, regardless of their actual market value at that time.
2. If the company performs well and its share price rises above the option price, employees can buy the shares at the cheaper, predetermined rate and potentially make a profit.

CSOPs are designed to align the interests of employees with those of the company and its shareholders, pulling everyone together towards mutual goals. 

CSOPs are tax-efficient for both the business and employees. What’s more, the gains the employee makes on exercise are also deductible from the company’s taxable profits, as are the costs of the scheme setup and management. It’s a win-win!

Key aspects of CSOPs

Let's unravel the characteristics that make a CSOP, a CSOP.

Flexibility

There are few eligibility requirements compared to schemes such as EMI. There’s also no cap on the number of employees, nor on the amount that can given by the company (only a per-employee cap of £60k).

Tax benefits

There’s no Income Tax or National Insurance to pay if the employee exercises (buys) their options three years after the options grant date. Skip to tax to learn more.

Vesting

When you award share options (like CSOP options) to employees, they can’t exercise (buy) them immediately, instead, they vest. In other words, they earn them over time. Skip to vesting to learn more.

The option to buy

CSOPs offer employees flexibility by giving them the right but not the obligation to buy the company shares. So they can choose to buy when it’s financially beneficial for them or choose not to (once vesting and exercise criteria are met).

Time limits

The tax benefits that kick in after three years from the grant date have a shelf life of 10 years. So the recipient has a seven-year window to benefit from them. 

That’s if you design an exercisable scheme. Now, if you design an exit-only scheme, the CSOP can continue after 10 years (so recipients won’t lose the right to their options) but the tax benefits will expire.

CSOP qualifying conditions

To qualify as a CSOP (and therefore benefit from tax relief) a number of conditions must be met across the board.

Employees

Only UK employees or directors with formal contracts are eligible for CSOPs. Unlike EMI there is no working time requirement for UK employees, only directors (see below).

Directors

Directors need to clock in at least 25 work hours per week, not counting meal breaks. This 25-hour rule is especially pertinent for those who serve on multiple boards within a tax-advantaged group scheme.

Material interest

If a recipient owns more than 30% of the company's issued share capital, they will not qualify for a CSOP.

Maximum value limit per recipient

The total value of CSOP options can't exceed £60,000, based on the unrestricted market value (UMV) at the time of each grant.

UMV values all the shares as if they had no restrictions and could easily be bought and sold at the prevailing worth of the company at the time.

The shares are in the top company

Companies can only use CSOP if they are not under the control of another company.

The benefits of CSOPs

Having the option to buy company shares is not just a cool perk – it offers material long-term benefits that could be potentially lucrative. 

Team alignment

Owning a slice of the company pie aligns professional ambitions with the company's broader goals. Essentially, employees become stakeholders with a vested interest in the company's success – ideal for creating high-performing teams. 

Employee retention

The three-year aspect of CSOPs encourages employees to stick around for that time, if not longer. As companies grow, a healthy retention rate is critical to maintain daily operations. And that’s without taking into account the current macroeconomic factors wreaking havoc on the job market.

Financial upside

When it comes to the financial benefits of a CSOP, the phrase "buy low, sell high" rings true. Through CSOPs, recipients purchase shares at an exercise or "strike" price, which is essentially a snapshot of the company's value at a given moment. 

The power of this setup is that recipients are buying future potential at present rates. If the company flourishes, the shares bought at yesterday’s price could soar in value, translating into significant financial gains.

Tax benefits

CSOPs are for the tax-savvy!

Employees who exercise their options and convert them into actual shares won't face any income tax or National Insurance at exercise on the appreciated value, provided they do so between 3 and 10 years from the grant date. 

When they then sell those shares – they will pay standard Capital Gains Tax (CGT) on the profit from the exercise price to the sale price.

EMI alternative

EMI is the most tax-efficient share option scheme in the UK and that’s that. However, a CSOP is a good alternative for those who have outgrown EMI, were never eligible, or have ruled out growth shares.

The nuts and bolts: how does a CSOP work?

Let’s take a deep dive into the mechanics that make up a CSOP. 

The exercise price 

The price the recipient pays to buy the company's shares remains fixed from the time of the initial agreement. 

This price serves as a significant advantage, especially for tax purposes. When the recipient "exercises" their options – i.e., convert them into actual shares – they won't face any income tax on the appreciated value, provided they do so between three and 10 years from the grant date.

One of the key guidelines from HMRC is about setting the exercise price of the share options. This is the price at which the employee will be able to buy the company's shares in the future.

HMRC mandates that this price must be set at the fair market value of the shares on the date the options are granted. This value is commonly called the "UMV" on the HMRC valuation. This is the difference between it being a CSOP or not.

So while a formal HMRC valuation is not essential, it’s wise to get one to be sure that you’re setting the right price. 

Vesting

Think of vesting as a roadmap outlining when employees earn the right to their CSOP options as well as when and under what conditions they can exercise them.

Vesting conditions

Many CSOPs include performance-related conditions. These could be related to the company’s overall performance, the department's or even individual targets that need to be met before recipients can vest their options.

Vesting schedules

Vesting can be time-based or condition-based (as above). A vesting schedule will clearly show the recipient what time milestones they have to reach to earn the right to keep their options. 

Now, just because a recipient has met their vesting conditions does not necessarily mean they can exercise their options. That all depends on whether the CSOP is exit-only or exercisable.

The anatomy of a vesting schedule

What to expect:

• The vesting period: This is the total time over which options fully vest. The range can vary, but it's often between three to five years.
• The cliff: Many schedules include a "cliff," usually a one-year period at the start during which no shares vest. If a recipient leaves the company before the cliff period ends, they forfeit their options.
• Exit acceleration provisions: Some schedules include clauses that can speed up vesting. For example, if the company gets acquired, shares might vest immediately, making them eligible to buy all their allocated shares immediately.
• Condition-based vesting: Individual or collective performance-based milestones or targets. For example, increase monthly sales by 20% per year or close £5k worth of deals in Q1.

Why vesting matters

Vesting serves several purposes for CSOPs and other share option plans:

• Retention: By tying the full value of the CSOP to a future date, companies incentivise employees to stick around and contribute to long-term success.
• Alignment: As options vest over time, employees become increasingly invested in the company's success, effectively aligning financial interests with the company’s performance. This pulls together the company and team towards a collective goal or horizon where everyone is rewarded. 

Vesting and Vestd

Designing a vesting schedule is easy with Vestd!

Once you’ve set up time-based vesting, the platform sends recipients notifications automatically every time their options vest so you don’t have to, which serves as a friendly reminder of what they stand to gain if they stick around!

They can keep an eye on the current worth of their vested and unvested options. And model scenarios to predict future gains. Actually seeing all of this on-screen makes their equity reward feel real and within their reach. And this is the main reason why the shareholder dashboards are so powerful.

Taxes and CSOPs

CSOPs are exempt from Income Tax and National insurance (subject to rules being satisfied) but remain subject to Capital Gains Tax (CGT). The good news is that everyone has a CGT allowance, which is tax-free. 

Let's delve into the specifics of CGT and how it relates to CSOPs.

What is CGT?

CGT is the tax paid on the profit when someone sells an asset that has increased in value. It's the gain that's taxed, not the amount of money received.

In the context of CSOPs, recipients would be responsible for paying CGT on the difference between the exercise price (the price at which they buy the shares) and the sale price (the price at which they sell the shares).

The CGT Annual Exemption

For the fiscal year 2023/24, the CGT annual exemption is £6,000, and it will be £3,000 for 2024/25. Recipients can gain up to this amount from selling their shares before applying any tax.

Standard CGT rate

Beyond the annual exemption, capital gains are taxed at a standard rate of 20%. It's essential to account for this when calculating potential net profits.