27 Share-based payments

During the period ended 31 December 2006, the following material share-based payment arrangements existed, which are described below:

Notes:

1. The granting of options under this scheme ceased with the last grant made in March 2004. Eligible individuals are entitled to participate in the Long Term Incentive Plan and Deferred Share Bonus Scheme.
2. Nil-cost options exercisable three years from date of grant, with payout subject to performance conditions based on earnings per share relative to inflation (50 per cent of grant) and total shareholder return, combining the share price and dividend performance of the Company by reference to two comparator groups (50 per cent of grant). Participants are not entitled to dividends prior to the exercise of the options. For grants made in 2005 and thereafter, a cash equivalent dividend will accrue through the vesting period and will be paid on vesting.
3. Free shares released three years from date of grant and may be subject to forfeit if participant leaves employment before the end of the three year holding period. Participants receive a separate payment equivalent to a proportion of the dividend during the holding period.
4. Options granted by invitation at a 20 per cent discount to the market price. Options are exercisable at the end of a three year or five year savings contract. Participants are not entitled to dividends prior to the exercise of the options.
5. Options exercisable three years from date of grant and subject to earnings per share performance condition relative to inflation. Participants are not entitled to receive dividends in the period prior to the exercise of the options.
6. Free shares granted (maximum £3,000 in any year) subject to a three year holding period and may be subject to forfeit if the employee leaves within this period. Participants are entitled to receive dividends during the holding period which are reinvested to buy further shares.

During the period, the Company operated a Partnership Share Scheme, which was open to all eligible employees, where employees can allocate part of their pre-tax salary to purchase shares in British American Tobacco p.l.c. The maximum amount that can be allocated in this way to any individual is £1,500 in any tax year. The shares purchased are held in a UK-based trust and are normally capable of transfer to participants tax free after a five year holding period.

Further details on the operation of share-based payment arrangements can be found in the Remuneration Report.

Share option schemes

Details of the movements for equity-settled share option schemes during the years ended 31 December 2006 and31 December 2005 covering the Share Option and Sharesave Schemes were as follows. The last of the former B.A.T Industries Employee Share 'E' Option Scheme options were exercised in 2005.

In addition to the above options, the movement in nil-cost equity-settled options from the Long Term Incentive Plan was as follows:

The weighted average British American Tobacco p.l.c. share price at the date of exercise for share options exercised during the period was £13.94 (2005: £10.05). A detailed breakdown of the range of exercise prices for options outstanding for the years ended 31 December 2006 and 31 December 2005 is shown in the table below:

The weighted average fair value of equity-settled Share Option Schemes' shares granted during 2006 was £9.39 (2005: £6.81).

Assumptions used in the Black-Scholes models to determine the fair value of share options at grant date were as follows:

*Where two figures have been quoted for the Sharesave Schemes, the first number represents the assumptions for the three year savings contract and the second number for the five year savings contract.

Market condition features were incorporated into the Monte-Carlo models for the total shareholder return elements of the Long Term Incentive Plan, in determining fair value at grant date. Assumptions used in these models were as follows:

The expected British American Tobacco p.l.c. share price volatility was determined taking account of the daily share price movements over a five year period. The respective FMCG and FTSE 100 share price volatility and correlations were also determined over the same periods. The average expected term to exercise used in the models has been adjusted, based on management's best estimate, for the effects of non-transferability, exercise restrictions and behavioural conditions, forfeiture and historical experience.

The risk free rate has been determined from market yield curves for government gilts with outstanding terms equal to the average expected term to exercise for each relevant grant. The expected dividend yield was determined by calculating the yield from the last two declared dividends divided by the grant share price.

For grants containing earnings per share performance conditions, the payout calculation is based on the average of expectations published in analysts' forecasts.

Other equity share-based payment arrangements (other than share options)

Details of the movements of other equity share-based payment arrangements during the years ended 31 December 2006 and 31 December 2005, covering the Deferred Share Bonus and Share Reward Schemes, were as follows:

The shares outstanding for the year ended 31 December 2006 had a weighted average contractual life of 1.1 years (2005: 1.1 years).

The fair value for other equity share-based payment arrangements granted during the period was determined using the Black-Scholes model with the following input assumptions at their grant date:

The weighted average fair value of other equity share-based payment arrangements granted during 2006 was £13.14 (2005: £8.27).

Cash-settled share-based payment arrangements

The Group issues to certain employees cash-settled share-based payments that require the Group to pay the intrinsic value of these share-based payments to the employee at the date of exercise. The Group has recorded liabilities at the end of 2006 of £14,294,315 (2005: £13,359,675) of which £3,456,071 (2005: £2,698,902) was in respect of vested grants. Fair value was determined from the Black-Scholes and Monte-Carlo models, using assumptions revised at the balance sheet date for cash-settled share-based payment arrangements. The Group recorded total expenses of £9,306,250 in 2006 (2005: £11,581,489).

Details of movements for cash-settled arrangements in respect of the Share Option Scheme during the years ended 31 December 2006 and 31 December 2005, were as follows:

In addition to the above, the movement in other nil-cost cash-settled arrangements during the years ended 31 December 2006 and 31 December 2005, covering the Long Term Incentive Plan and Deferred Share Bonus Scheme, were as follows:

Assumptions used to determine the fair value of cash-settled share-based payment arrangements at date of grant, can be found in the sections relating to share option schemes and other equity share-based payment arrangements.

The weighted average British American Tobacco p.l.c. share price at the date of exercise for cash-settled share-based arrangements exercised during the period was £14.05 (2005: £10.05). A detailed breakdown of the range of exercise prices for cash-settled share-based payment arrangements outstanding for the years ended 31 December 2006 and31 December 2005 are shown in the table below:

Share-based payment expense

The amounts recognised in the Income Statement in respect of share-based payments were as follows:

 28 Group employees

The average number of persons employed by the Group and its associates during the year, including Directors, was 97,431 (2005: 96,952).

Details of Directors' remuneration, share options and retirement benefits are given in the Remuneration Report.

Included within the employee numbers for Europe are certain employees in the UK in respect of central functions. Some of the costs of these employees are allocated or charged to the various regions and markets in the Group.

 29 Related party disclosures

The Group has a number of transactions and relationships with related parties, as defined in IAS24 on related party disclosures, all of which are undertaken in the normal course of trading. Details of these are set out below.

Transactions and balances with associates relate mainly to the sale and purchase of cigarettes and tobacco leaf. Amounts receivable from associates in respect of dividends included in the table below were £48 million (2005: £45 million). The Group's share of dividends from associates included in other net income in the table below, was £267 million (2005: £202 million). Legal fees recovered from Reynolds American Inc. included in other net income amounted to £2 million (2005: £10 million).

As described in note 26, between 7 January 2005 and 20 December 2005 the Group had an interest in BARH Ltd., a joint venture between British American Tobacco and Honda Motor Co. Ltd. As part of this relationship, the Group had a funding obligation to BARH through to the end of 2006. Payments of US$67.5 million relating to Lucky Strike sponsorship for 2005 and 2006, were made during 2005 and these are included in the table above under other net income.

The key management personnel of British American Tobacco consist of the members of the Board of Directors of British American Tobacco p.l.c. and the members of the Management Board. No such person had any material interest during the year in a contract of significance (other than a service contract) with the Company or any subsidiary company. The term key management personnel in this context includes the respective members of their households.

There were no termination benefits paid or other long term benefits applicable in respect of key personnel.

Other than in their capacity as shareholders, there have been no material transactions with Compagnie Financière Richemont SA and Remgro Limited, who together indirectly own 29.2 per cent (2005: 28.6 per cent) of the fully diluted ordinary share capital of British American Tobacco p.l.c. at 31 December 2006.