Unapproved options and LTIPs

What is an unapproved option?

It is simply a right to acquire shares from a future date at a fixed price. The fixed price is commonly the shares’ value at the date the option is granted, the object being to provide a reward for the option holder based on future growth in share value.

However, the price is also frequently set at nil, so if the option is exercised the option holder simply calls for the shares to be transferred to him for no payment. Options with a nil exercise price or similar arrangements) are often called Long Term Incentive Plans (LTIPs).

“Unapproved” simply means that it hasn’t received Revenue approval for option holders to benefit from any tax breaks.

How does it work?

Unlike CSOP, EMI or SAYE options, any option gains (the difference between the price paid to exercise the option and the shares’ value on exercise) are normally subject to income tax and National Insurance (NI) (both employee and employer), when the option is exercised.

For an option granted to a higher rate taxpayer, this means the total tax arising from the exercise of an option is:

• 40% income tax
• 1% employee NI
• 12.8% employer NI

By agreement between the optionholder and the company, responsibility for the employer NI can be transferred to the optionholder, in which case the amount of option gain upon which they would pay the employer NI would be calculated after deduction of income tax.

Where a company can show that there is no short term way in which the optionholder can sell the shares acquired by option exercise (they are not readily convertible into cash), it may be possible to avoid a liability for NI.

When is tax due?

Income tax and employee NI will normally be collected under PAYE, following option exercise. However, where the shares are not readily convertible into cash, so only income tax is due, the employee who has exercised the option must declare their gain in their self-assessment tax return for the tax year in which the option is exercised.

Can we choose which of our employees participate?

Yes, you can choose any employee or executive director to participate.

Are there any limits?

It isn’t subject to any Revenue limits.

What happens to leavers?

You can write into the plan how leavers should be treated, according to your company’s own commercial requirements.

What happens if our company is taken over?

You can write into your plan what should happen on a takeover. For example, it could stipulate that:

• all options become exercisable even though any initial option period may not have passed; or
• a proportion of the options become exercisable, depending on how much time has passed between grant and takeover or depending on to what extent a performance target has been met.

Can my company have an unapproved plan?

Almost certainly.

What is the accounting impact?

The Accounting Standards Board requires a company providing share-based benefits for its employees to show that as a cost in its accounts. However, this accounting treatment will not currently apply to smaller companies whose accounts are prepared under FRSSE.

Are there any benefits for the company?

Apart from the potential commercial benefits of a carefully designed option plan (employee motivation, creating a sense of ownership and fostering commitment), any gains enjoyed by employees may in most cases be treated as an expense of the employer company for corporation tax purposes.

Is there anything else I need to know?

Yes, there is more information you’ll need to understand before deciding whether an unapproved option plan or LTIP may be the right solution.