Company share option plans can be a useful tax-efficient ingredient of executive reward, says Peta Hodge
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.
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.
For more articles on share schemes