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Consider your options

My last article considered one of the longest-standing share option arrangements – the SAYE share option scheme.

The next step in the consideration of approved share option schemes is the discretionary share option arrangement known as the company share option plan. This, in effect, is an extended but less restricted version of the SAYE scheme without the SAYE component.

Substantial changes to approved discretionary share option schemes have been introduced over the years, broadly speaking, to limit the number of shares over which options could be granted under these schemes.

The latest incarnation of the discretionary approved share option scheme is the new Enterprise Management Incentive scheme that I will consider later. But despite the introduction of the EMI scheme, the company share option plan continues to remain available although unexercised options held under such a plan will need to be taken into account in determining the maximum options available under the EMI scheme.

The main difference between an approved and unapproved scheme is the fact that, under an approved scheme, there is no taxation consequence attaching to the exercise of an option. When the shares acquired by virtue of the option are disposed of, any gains accruing by reason of the disposal price exceeding the price paid on exercise of the option would be subject to capital gains tax, not income tax. This means the indexation allowance (up to 1998), taper relief (from then on) and the annual exemption (to the extent it has not already been used) would be available.

There are comprehensive Inland Revenue guidance notes on approved share option schemes explaining the procedure for gaining approval. It is generally recommended that informal approval for the draft rules is obtained before they are adopted. This would then enable the company to avoid last-minute changes.

Importantly, if the company issuing the share options is not one quoted on a recognised stock exchange, the market value of the shares over which the options are being granted must be agreed with the Inland Revenue before the scheme is approved.

Currently, the maximum value of shares over which options can be held by any one individual is £30,000. It is important to note that this is a total, not an annual limit.

The value relates to the value of the shares when the options were issued, not at any other time.

As stated above, the company share option plan is tax-neutral until the shares acquired under the option are disposed of, when capital gains tax rather than income tax would be relevant.

The attraction of this plan – which may well be superseded in effect (though there are understood to be no formal plans for its phasing out) by the EMI scheme – is that it does not have to made available to all employees and can be open to any one, on a discretionary basis, provided that the person to whom the option will be granted is either a full-time director or qualifying employee and does not have a material interest in the company if it is a close company.

For these purposes, full time means a minimum of 25 hours a week, qualifying employees include part-time employees and material interest, broadly speaking, means owning more than 10 per cent of the company&#39s ordinary share capital.

The rules in respect of the timing of the exercise of options under an approved scheme are that the options must not be exercisable later than 10 years after they have been granted and may not be exercised within three years of the grant. Exercise of any option within three years of the exercise of any other option over shares in the same company should not be permitted.

The price at which the option may be exercised under a company share option plan should not be manifestly less than the market value of the shares when the option is granted.

While the company share option plan continues to be available, it is thought that the advent of the EMI scheme, with its greater limits in respect of the value of options that can be held, may well cause the discretionary approved share option scheme as we know it to attract less interest. I will look at the EMI scheme next week.

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