Share incentive schemes: New opportunity for SME businesses
24th January 2023
Although the government’s October 2022 Growth Plan has been largely reversed, one important change to share incentive schemes has survived.
The rules applying to Company Share Option Plans (known as CSOPs) are to be changed from April 2023 to increase the number of companies which can introduce CSOPs.
Share incentive schemes can offer companies an important way of delivering tax and cashflow efficient reward to employees against a background of wage inflation and workforce shortages.
The changes are particularly helpful for companies that have looked at introducing share schemes through an Enterprise Management Incentive Scheme (an EMI scheme) but have not been able to satisfy the conditions applying to EMI schemes. A CSOP scheme may now be an alternative route for such companies to introduce a tax efficient share scheme.
Why introduce a share incentive scheme?
Share incentive schemes give selected employees an option to acquire shares in the employing company or group which is exercisable at a future date. The opportunity to acquire shares offers a powerful way of rewarding and retaining key employees, particularly where exercise of the share option is linked to growth in the company’s value and/or a sale or other exit by the majority shareholder.
A share incentive scheme is also a tax efficient way of delivering reward where the conditions for a “tax-advantaged” scheme such as an EMI or CSOP are met. Gains made on exercise of options meeting the conditions will be subject to capital gains tax, rather than income tax, and employees’ and employers’ National Insurance Contributions will not be payable.
A further tax benefit is that the employing company will usually be able to treat the option gain as deductible in calculating its corporation tax liability.
Please contact our Tax Director Nicola Parkinson with any queries.
When can a CSOP be used by an SME business?
A CSOP can be used by a company which is not under the control of any other company. Under a CSOP, an option is exercisable at the market value of the shares when the option is granted and the gain is outside the scope of income tax as long as exercise is at least 3 years after grant. Earlier exercise with the benefit of tax relief is permitted but only in limited circumstances. Exercise can be linked to achievement of company performance targets or a realisation event (such as a sale of the company).
Options can be granted to an employee over shares with an aggregate value of £30,000 – to be raised to £60,000 from April 2023 under the government proposals.
A key change announced by the government is to allow CSOP options to be granted by companies with more than one class of shares. Currently, it is difficult to meet CSOP conditions where a company has more than one class of shares. This has proved an obstacle to CSOPs in SMEs where there are often multiple share classes tailored to the groups of stakeholders such as venture capital or other external investors, the company founders and employees.
As with EMI schemes, an employee or director with a material (broadly, 30% or more) shareholding in the company cannot be granted a qualifying CSOP option.
Why use a CSOP instead of an EMI scheme?
Most SME companies that want to introduce share incentive schemes will first consider using an EMI scheme. If the EMI conditions can be met, EMI options have in some respects more flexibility than CSOP options and the capital gain on an EMI option can be taxed at a lower rate of CGT than that applied to a CSOP option gain.
However, some companies cannot meet the conditions for an EMI scheme, the two main reasons being:
- Businesses excluded from EMI schemes. Companies carrying on certain “excluded” activities cannot use an EMI scheme. These activities include property dealing or development, operating a care home, operating a hotel, certain royalty licensing activities and financing and related activities. These restrictions do not apply to CSOP options; or
- Limits on company’s size and employees. EMI options cannot be granted where a company (and its group) has gross assets of more than £30,000,000 or 250 or more full time employees at the time of option grant. These limits do not apply to CSOP schemes.
Companies which cannot meet the EMI conditions will be particularly interested in the CSOP changes as a tax advantaged CSOP may be possible where an EMI scheme cannot be used.
Companies which have considered CSOPs as an alternative to EMI schemes but have found the rules too restrictive could look again as the relaxation to allow companies with multiple share classes to use a CSOP scheme could assist.
Is the individual limit on CSOP options a problem?
An employee can hold CSOP options with a maximum total exercise price of £30,000 – to be increased to £60,000 from April 2023 under the government’s proposals.
Although the limit is much lower than the EMI limit of £250,000, it will not necessarily be an obstacle. Many companies introducing share incentive schemes will want to reward future growth in value so will consider granting options over “growth shares”. Growth shares have little to no rights to current value of the company giving them only a low value when options are issued but which grow in value in line with the company’s performance.
The low value of growth shares when options are granted means that meaningful option grants can be made within the individual limits and with a much lower exercise price.
How we can help with share incentive schemes
Our Tax Team has extensive experience of working with SME companies to introduce share incentive schemes. We work with clients on design of schemes, rollout of option awards, communication with employees and eventual exercise on exit or other events. Please get in touch.
