UK: Company share option plans (CSOP) can be a useful tax-efficient ingredient of executive reward, says Peta Hodge - 1 Mar 2010

2010-03-01

Company share option plans can be a useful tax-efficient ingredient of executive reward, says Peta Hodge

orig posting

Ever since last April's Budget, when Chancellor Alistair Darling
announced a new 50% tax band for those earning over £150,000 a year
from 2010-11, there has been renewed interest in benefits with the
potential to reduce the tax burden for high earners. Company share
option plans (Csops) are one such benefit.

In a single day in January, for example, share plan consultancy RM2
received enquiries from 12 potential Csop clients, which is
considerably more than it would expect, says partner Colin Paterson.

Neil Sharpe, principal at executive remuneration consultants Hewitt
New Bridge Street, says: "There has been an increasing interest because
the gains made are subject to capital gains tax when the shares are
sold, at 18%, rather than income tax, which can be up to 50%, with
national insurance contributions on top of that."

Useful aid to staff retention

There is another reason why more employers are looking at setting up
a Csop, says Paterson. "As companies pull through the recession, many
do not have the cash they thought they might have, so it is a good way
of holding on to people in difficult times."

It also helps that many companies' share price, after a period in
the doldrums, now appears to be moving upward. Sharpe says: "Csops are
good if the share price is rising, which is why options went out of
fashion in the last 10 years, because shares got more volatile. Now is
a good time to put one in. Six months ago might have been even better."

Traditionally, Csops have been used as part of an executive
remuneration package for a few staff, rather than for many. This
explains the fact that although more companies operate Csops than
sharesave or share incentive plans (Sips), they cover far fewer
employees. More than 2,000 companies operated Csops last year,
according to figures from HM Revenue and Customs (HMRC).

Schemes being set up now are used primarily for executive
remuneration, but the focus is usually on middle managers rather than
top directors, says Sharpe.

Rare to offer Csop to all staff

With a £30,000 limit on the approved (and therefore tax-efficient)
part of a Csop, the plans might be included in the package of bonuses
for very high earners, but their usefulness as a tool for motivating or
retaining senior staff is likely to be limited. It is rare to offer a
Csop to all employees.

Employers that have set up Csops in recent months come from various
business sectors but, in general, knowledge-based industries tend to be
most interested in equity-based schemes, says Paterson. "In part, this
is because softer benefits are more important in knowledge-based
businesses because the people are the assets of the firm. It is
important they buy into the corporate objectives and benefit from the
achievement of those objectives in a direct financial way."

From an employer's point of view, one of the attractions of Csops is
that, as long as the plans meet HMRC requirements, they are fairly easy
to set up and administer. Julie Richardson, head of employee share
ownership at industry body IFS ProShare, says: "Employers probably just
need to speak to their professional advisers to get them to help draw
up a set of plan rules that will meet their requirements.

"Employers have to get HMRC approval if they are doing the approved
element of it. They are also going to have to get shareholder approval.
But once they have done that, it is a fairly simple plan to communicate
as well."

Simpler than sharesave or Sips

Sharpe adds: "Csops are simpler than either sharesave or Sips
because they do not involve any employee money until the end. So
companies can grant the options and then there is nothing else to do
until they become exercisable."

The advent of web-based systems has further eased the administrative
burden. Facilities such as online exercise have helped make the plans
more attractive, says Sharpe. "That is becoming the norm now, as the
use of paper for exercising is decreasing."

Web-based communication has been central to the success of Henderson
Global Investors' plan (see panel below). Jeremy Mindell, senior reward
and tax manager at the company, says: "It is much easier to do because
everything is on screen. When staff sign up, they can look at things on
screen. When it comes to exercise, they can do that through the
technology, and can work out the pro-ration if they are an early
leaver. So it reduces the administrative burden associated with option
plans."

However, the big potential downside of Csops is the very essence of
options - neither employer nor employee can know whether the benefit is
going to be worth anything. "The interesting thing about granting now
is that these options do not usually become exercisable for three
years," says Sharpe. "There is always this lag between putting a plan
in and thinking it is a good idea, and finding out if it actually
delivers a benefit.

Share price falls

"Then, of course, what has happened in the past is the share price
has fallen, loads of options cannot be exercised because they are
underwater, the popularity of the plan goes down, the company decides
not to grant any more, and that is often just at the time they should
be using a plan."

With that in mind, employers may wonder whether Csops are popular
with staff. "I think employees probably prefer other types of reward,"
says Sharpe. "Either sharesave schemes, because [staff] have got that
savings account and they have often got a 20% discount on the option
price, so the share price has to fall quite a way for the options to be
underwater. Or free shares [through a Sip] because even if the price
goes down, at least staff have got some shares."

So, while right now there are many good reasons for employers to
include Csops as part of a bonus package, they need to be complemented
with other types of reward to be used to maximum effect.

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Case study: Henderson Global Investors

Henderson Global Investors is in the vanguard of promoting employee
share ownership, so has taken the unusual step of offering its Csop on
a global, all-employee basis.

Jeremy Mindell, senior reward and tax manager at Henderson, says the
company originally offered a much smaller version to executives only,
but decided to extend the scheme to all 900 staff in an effort to boost
staff retention. The tax treatment of Csops was a major attraction, as
was the cost. "It was relatively cheap to put in, sends quite a
positive message to people and gives them the prospect of potentially
quite substantial rewards in 2012," says Mindell.

The timing of the scheme's launch, in March 2009, could hardly have been better, he says. "It is well in the money."

Mindell says Csops have tended to be overlooked in recent years.
"They have a place in a remuneration and reward package, just like
everything else. But [employers] would not want them to be their only
tool."

†

How Csops work

Under a company share option plan (Csop), staff are granted a right
(known as an option) to buy a fixed number of shares, at a fixed price,
at a set time.

As long as the plan is HM Revenue and Customs-approved and the rules
are followed, there is no income tax or national insurance (NI)
liability when staff exercise their option and buy the shares.

The total value of shares held by an employee under an approved Csop
or other approved discretionary scheme must not exceed £30,000. Options
granted in excess of £30,000 can be held as unapproved options, but do
not benefit from the same income tax or NI relief.

A minimum of three years must pass between grant and exercise. After
exercise, there may be a liability to capital gains tax on any gain
between the sale price and the exercise price.

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For more articles on share schemes