How employees qualify for CSOP tax benefits, non-qualifying CSOP tax liabilities, and CT relief for companies.
The Company Share Option Scheme (CSOP) is a tax-advantaged scheme backed by HMRC, but there are some caveats to be aware of for employees to qualify for the tax benefits.
Before we get into the criteria, let’s go over the tax benefits themselves.
First, there is no tax liability created on the grant or exercise of the CSOP, only when the employee sells their shares.
And when the shares are sold, the difference between the exercise price and the share sale price will be subject to Capital Gains Tax at 20%.
As you can see, the CSOP tax benefits work in the favour of the employee, as their only tax liability is created when the shares are sold. Or in other words, when they have made a taxable profit – so they will never be out of pocket.
Now let's see what the employee has to do to qualify for the CSOP tax benefits.
How to qualify for CSOP tax benefits
As CSOP tax benefits/liabilities are only created on the exercise of the option, the qualification aspect centres around when the employee exercises too.
As long as the CSOP is exercised at least 3 years after the grant date – but within 10 years – the employee won’t face any tax liabilities on exercise, only when they sell their shares.
However, if the company goes through an exit event within 3 years of the grant date, then recipients won’t face any tax liabilities on exercise – just CGT on the sale of the shares.
There are also 6 exemption clauses that allow CSOPs to be exercised within 3 years and retain the tax benefits. These clauses cover specific leaver scenarios and aren’t statutory requirements, so they might not be included in the agreement. If you’re unsure, contact the granting company to confirm.
Exercising a non-qualifying CSOP
If the CSOP is exercised within 3 years and doesn’t meet one of the 6 exemption clauses, Income Tax is due on the difference between the exercise price and the market value of the shares at the time of exercise.
When the shares can’t be sold immediately, the option holder can choose whether to pay Income Tax on the difference between the exercise price and either the AMV or UMV of the shares at the time of exercise.
- If they choose the likely higher UMV, they will have a higher Income Tax bill at the point of exercise, based on the difference between the exercise price and the UMV. But any gain from this point onwards will be subject to Capital Gains Tax as they have already paid all the Income Tax owed.
- The recipient and employing company must complete a joint ITEPA S431 election within 14 days to ensure no further Income Tax is liable.
- If they choose to be taxed based on the AMV, they will have a lower Income Tax bill at the point of exercise, based on the difference between the exercise price and the AMV. But on eventual sale, the percentage difference between AMV and UMV that was saved on exercise will be applied to any further gains, meaning they are likely to be exposed to both Income Tax and Capital Gains Tax on the sale of the shares.
When you exercise your CSOP through Vestd (as long as the company has supplied it) we’ll highlight both the AMV and UMV at the time of exercise on your agreement summary page, so you can determine how much tax you owe.
What happens when an employee leaves?
Unlike EMI, where the tax benefits are lost after leaving the company, CSOP tax benefits remain, as long as the options are exercised 3 years after the leaver’s grant date.
Of course, an employee’s ability to exercise their CSOP after leaving the company depends on the leaver clause in their agreement.
For example, if the leaver clause was ‘allow vested options to be exercised,’ the employee can exercise their options on leaving, but whether or not they qualify for the CSOP tax benefits depends on the length of time they have held the CSOP.
If it’s over 3 years, they will qualify. If not, then the same conditions under ‘exercising a non-qualifying CSOP’ apply, unless they meet one of the 6 exemptions (if the agreement allows).
Likewise, if the leaver clause is ‘keep vested options’ and the agreement is exercisable, the employee has no urgency to exercise, so they can hold their vested options past the 3-year period, then exercise to qualify for the tax benefits (if the agreement allows).
Going back to the 6 exemption clauses, if an employee leaves for one of those reasons, then they will have up to 6 months to exercise their options to retain the CSOP tax benefits – regardless of how long they have held the CSOP.
Does the granting company receive any tax benefits?
Yes, companies can qualify for a Corporation Tax deduction. When a CSOP is exercised, the realised gain can be deducted from company profits which will reduce the CT liability due.
For example, a company’s taxable profit for the year is £1 million, and in that year 5 employees exercise their CSOPs for a combined realised gain of £100,000. The gain is taken from company profits to reduce the taxable profit to £900,000.
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