A share option is a contract pursuant to which one party has the right (but not the obligation) to acquire shares from another person or to sell shares to another person at a specific price (or at a price calculated according to a specified formula) on a particular date or a range of dates or at any time during a period specified in the contract.
In general terms, there are 3 basic types of share option. These are:
A put option enables the optionholder to require another person to buy the optionholder’s shares (or, sometimes, some of them) in accordance with the terms and conditions specified in the put option agreement.
A call option enables the optionholder to require another person to sell their shares (or, sometimes, some of them) to the optionholder in accordance with the terms and conditions specified in the call option agreement.
A put and call option is a combination of a put option and a call option. These can be drafted in several ways. It may enable the optionholder to require another person to buy the optionholder’s shares (or, sometimes, some of them) or to require another person to sell their shares (or, sometimes, some of them) to the optionholder (as the optionholder determines) in accordance with the terms and conditions specified in the put and call option agreement.
A share option agreement is the document which sets out the terms and conditions of the arrangement between the holder of the share option and the person (the ‘Grantor’) who grants the right to put and/or call shares to the optionholder).
There are a number of key issues to be considered in connection with share option agreements. These include:
(a) Nature of the option – Will it be a put option, a call option or a put and call option?
(b) Option price – Will the optionholder have to pay the Grantor for the granting of the option rights to the optionholder? This is separate from the issue of the price to be paid for the purchase of shares pursuant to the share option. The price for the granting of the option rights is often a nominal amount.
(c) Exercise date or period – What is the date, series of dates or period during which the share option can be exercised?
(d) Exercise price – Will there be a specific price per share for the purchase of shares pursuant to the share option or a formula?
(e) Conditions – Will there be any conditions precedent to the exercise of any share option?
(f) Term of the share option agreement – How long will the share option agreement last? A share option agreement is usually granted for a defined period of time. It may also terminate early in certain circumstances.
(g) Approval – Will the approval of the shareholders, board and/or any third parties (for example, lenders or HMRC) be required? The approval of HMRC may be required in the case of share options pursuant to Employee Share Schemes.
(h) Other agreements – Will any other agreements be required? Sometimes, optionholders are required to enter into a shareholders’ agreement or to sign a deed of adherence to a shareholders’ agreement when exercising an option to acquire shares.
A share option scheme is simply a scheme established by a company pursuant to which members of the scheme may acquire shares or, in certain cases, rights relating to or equivalent to shares. A share option scheme may be a traditional unapproved scheme or it may be an approved scheme. Approved share option schemes are schemes which are approved by HMRC. They offer a range of tax benefits to employers and employees.
Share option schemes or plans which carry tax advantages include:
CSOPs are tax-advantaged share plans which enable a company setting up a CSOP to grant options to employees to acquire share in the company. In order to obtain the potentially favourable tax treatment various statutory conditions must be met. If they are not met then the share option plan will not qualify and the share options granted under it will be a fully taxable.
CSOPs are sometimes used where the relevant company is unable to offer an Enterprise Management Incentives options under an EMI Scheme.
The company has a broad discretion as to which employees can participate in its CSOP. However, CSOP share options can only be granted to employees and “full-time” directors, who do not have a “material interest” in the company which has set up the CSOP (or in certain related companies).
HMRC interprets "full-time" as meaning at least 25 hours per week, excluding meal breaks. For the purposes of CSOPs, an employee or director has a “material interest” if either (i) it is the beneficial owner of more than 30% of the ordinary share capital of the company or has the ability to control more than 30% of the ordinary share capital either directly or indirectly, or (ii) it has the right to receive more than 30% of the assets available for distribution on a winding-up or in any other circumstances (or the entitlement to acquire such rights).
The share option price relating to share options granted under a CSOP cannot be set at a discount to the market value of the shares at the time at which the share option is granted. The market value should be agreed in advance with HMRC except in the case of shares listed on a recognised stock exchange. No more than £30,000 worth of shares can be awarded to any individual employee or director.
EMI Schemes are tax efficient share option schemes, which are specifically targeted at small, higher-risk trading companies.
EMI share options can be granted over the shares of any qualifying company whether it is incorporated in or outside the UK. In order to qualify, the company must comply with a number of statutory requirements, some of which must only be met at the time of grant of the EMI share options and others must be met throughout the period of the EMI share options. The statutory requirements include requirements that the company must (i) be independent of other companies, (ii) have only qualifying subsidiaries, (iii) have gross assets of no more than £30 million at the time of grant of the share options, (iv) have fewer than the equivalent of 250 full-time employees at the time of grant of the share options, (v) be a trading company (or the parent company of a trading group), and (vi) have a UK permanent establishment.
EMI share options can only be granted to employees, who do not have a “material interest” in the company which has set up the EMI Scheme (or in certain related group companies). An employee must work for the company (or a group company) for at least 25 hours per week or, if less, 75% of their working time. For the purposes of EMI Schemes, an employee or director has a “material interest” if either (i) it is the beneficial owner of more than 30% of the ordinary share capital of the company or has the ability to control more than 30% of the ordinary share capital either directly or indirectly, or (ii) if the relevant company is a close company, it has the right to receive more than 30% of the assets available for distribution on a winding-up or in any other circumstances (or the entitlement to acquire such rights).
A company cannot grant EMI share options over more than £3 million worth of shares at any one time. An employee is able to hold unexercised EMI options over shares worth up to the current statutory EMI share option individual limit. This is currently £250,000.
The exercise price of an EMI share option can be set at any level. Where existing shares are used rather than new shares, the exercise price can be nil. Setting an exercise price that is less than market value at grant may have tax consequences on exercise of the EMI share option.
SAYE Schemes are Government-backed savings-related share schemes where the employees of a company can buy shares in accordance with the rules of the scheme with their savings for a fixed price. They are sometimes called sharesave schemes, save as you earn option schemes or savings related share option schemes.
All of the UK resident employees of a company offering an SAYE Scheme must be able to participate in the scheme. Subject to certain limitations, other employees may also be included in the scheme. However, the company may include a qualifying period of service. That period cannot be more than five years.
The grant of the option is conditional on the employee taking out a linked HMRC-certified savings arrangement with a bank or building society to save up the option exercise price. An employee who participates in a company SAYE Scheme is required to save between £5 and £500 per month for three or five years. At the end of the savings arrangement, the employee can use the savings to buy shares.
The share option price relating to share options granted under an SAYE Scheme can be set at a discount to the market value of the shares at the time at which the share option is granted. That discount cannot be more than 20% of the market value of the shares.
SAYE Schemes offer tax incentives for employees who participate in the option scheme provided that the share option scheme complies with the relevant statutory requirements.
SIPs are tax-advantaged share plans which allow employees to acquire shares in their employer (or its parent company). There are 4 different types of share that can be awarded under a SIP – free shares, partnership shares, matching shares and dividend shares.
All of the UK resident employees of a company offering an SAYE Scheme must be able to participate in the scheme. Subject to certain limitations, other employees may also be included in the scheme. However, the company may include a qualifying period of service. That period may vary depending on the type of SIP shares.
Every director or employee who meets the eligibility requirements must be able to participate in the SIP on "the same terms" and those employees who do participate must actually participate on the same terms. A SIP must not have any feature that causes the benefits to be conferred wholly or mainly on the directors and more highly paid employees or include conditions on participation other than those required or authorised by the SIP code.
The SIP code requires that the scheme organiser must establish a trust to acquire and hold the SIP shares on behalf of participants. Every trustee must be resident in the UK for tax purposes.A SIP can be operated in relation to the shares of any company (including one incorporated outside the UK) that meets the relevant requirements on the date on which the shares are awarded. These requirements include those relating to the identity of the company, its status and the nature of the shares subject to the SIP.
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