The approved executive share option scheme was introduced by the Government in 1984, and immediately became an important part of the remuneration packages offered to top executives.
After October 1987, however, when the market fell, many executives found themselves holding share option certificates that were worthless, as the option price was higher than the market price of the shares.
But times change, and many executives granted options at the bottom of the market are now sitting on handsome paper profits. Not surprisingly, there has recently been some profit-taking in the market, and now is the time for employees to dust down their old share option certificates and consider whether they should exercise their options.
The price at which the options can be exercised must be fixed when the options are granted and must not be less than the market value of the shares at the date of grant.
An exception to this rule is that options can be granted at a 15 per cent discount to market value in cases where the company also has an all-employee share scheme. Institutional investors are generally opposed to the 15 per cent discount.
Under an approved share option scheme, employees can be granted options over shares up to pounds 100,000 or four times salary if that is greater. Thus an employee earning pounds 50,000 could have options over pounds 200,000 worth of shares, whereas an employee earning pounds 20,000 could still have options over pounds 100,000 worth of shares.
There will usually be no income tax on either the grant or the exercise of the option. There will, however, be a liability to capital gains tax on the ultimate disposal of the shares. But if the gain comes within the pounds 5,800 annual allowance, there will be no CGT to pay.
To avoid any tax traps, the options should not be exercised earlier than three years from the grant date. The options must be exercised within 10 years from the grant date. There must also be a three-year gap between the last non-taxable exercise and the next exercise date.
Before individuals can exercise their options they will need to check whether any performance criteria were attached to the exercise. Publicly quoted companies are encouraged by their institutional investors to attach performance criteria - for example, that there should have been real growth in earnings per share - before individuals can exercise their options.
Fortunately, the legislation allows for the early exercise of options in certain circumstances, which broadly fall under two categories of 'clemency' and 'takeover'.
If an employee retires, is injured, disabled or is made redundant, options may be exercised within six months of leaving employment. If an employee dies leaving unexercised options, the personal representatives can exercise the option within 12 months.
Options would normally lapse if the individual ceases to be employed by the company for any other reason. But some scheme rules allow options to be exercised in such circumstances at the discretion of the directors. If an employing company leaves the group, options can be exercised within six months of that date.
Employees holding share options in a company that is taken over also have six months.
Brian Friedman heads the employee benefits practice at Arthur Andersen. .