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:
- The company/employer decides to issue shares,
- The employee decides to exercise/buy issued shares,
- 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.
Prerequisites of ESOP:
Following are the prerequisite of ESOP:
- An employer has the right to decide who can avail ESOP,
- An employee needs to go through the pre-defined vesting period ie., an employee has to work for the company until a part or the entire stock options could be exercised,
- The company/employer grants ESOPs to its employees for a Specified Number of Shares of the company at a Pre-determined Price after the option period (a certain number of years).
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:
- For attracting and retaining high-quality employees,
- Making employees stakeholders of the company,
- The company can avoid cash compensation as a reward, thus saving on immediate cash outflow.
Following are the benefits of ESOP to an Employee:
- The benefit of acquiring the shares of the company at the nominal rate, and sell them (after a defined tenure set by his employer) and make a profit,
- Compensation of hard work in the form of ownership interest in the company.
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:
- 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.
- 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.
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.
No. An employee has the right whether to exercise the option to buy the shares offered via ESOP or not.
Employees may cash out from an ESOPs plan based on the terms listed in the plan guidelines.
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.