ESOP : Employee Stock Ownership Plan

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Hiral Vakil

Capital Gains
ESOP
Salary Income

ESOP (Employee Stock Ownership Plan) is an Employee Benefit Plan provided by the company/employer. ESOP allows an employee to buy a stock of their company at a below-market price. It also offers ownership interest to employees. ESOPs can be issued in as Direct Stock, Profit-Sharing Plans or Bonus. ESOPs is the three-step process:

  1. The company/employer decides to issue shares,
  2. The employee decides to exercise/buy issued shares,
  3. The employee decides to sell shares.

Before granting ESOPs to employees, an employer needs to follow Rules and Regulations relating to ESOPs are as per Companies Act 2013.

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Prerequisites of ESOP:

Following are the prerequisite of ESOP:

Benefits of ESOP

The purpose of ESOP is to give benefit to both the Employer/Company and Employee. Startup eco-systems widely use ESOPs.

Following are the benefits of ESOP to the Employer/Company:

Following are the benefits of ESOP to an Employee:

Tax Implications of ESOP

It is important to understand the tax implications of ESOPs in India before the employer considers implementing an ESOP scheme.

Employee: ESOPs are taxed at the following two times:

  1. At the time of Exercising ESOP: It is considered as a Perquisite under Salary Income Head. Hence when an employee exercises his option, the difference between Fair Market Value (FMV) as on date of exercise and the exercise price is taxable as a perquisite.
  2. At the time of Selling: It is considered as Capital Gain. An employee might sell his/her shares after buying them. In case he/she sells these shares at a price higher than FMV on the exercise date, he/she would be liable for capital gains tax.
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Employer: Contributions to the ESOP are tax-deductible as they are made to repay the loan amount. Both principal and interest are tax-deductible. But Once ESOPs are executed, the employer/company needs a proper administration including the third-party administration, trustee, valuation, legal costs. Hence it will be the burden of ongoing cost for a company/employer.

FAQs

Is it mandatory to buy shares offered via ESOPs by the company/employer?

No. An employee has the right whether to exercise the option to buy the shares offered via ESOP or not.

Can I cash out my ESOPs?

Employees may cash out from an ESOPs plan based on the terms listed in the plan guidelines.

What happens to my ESOP if I leave the company?

If your company offers an ESOP, or employee stock ownership plan. You own shares of the company’s stock as part of your retirement benefits. However, if you quit, you only will receive the amount of stock that has been vested, or completely given to you during your tenure.

  • V. Raja says:

    Do we have to check the valuation of the Company before coming out with an ESOP plan?

    • Hiral Vakil says:

      Yes, the valuation of the company will be done before coming out with an ESOP. However, it depends on the type of company:

      1. In the case of listed companies: At the time of grant of an option valuation of fair Market value of shares shall be done by a registered valuer. And at the time of exercise of an option, the valuation shall be done by Merchant banker.

      2. In the case of Unlisted companies: At the time of grant and exercise of an option valuation of Fair value of shares shall be done by a registered valuer as per “Guidance note on accounting for employee share-based payment”.

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