What is ESOP?
Employee Stock Option Plans ‘ESOPs’ entitle employees the right to purchase or benefit or subscribe for the shares of the company at the predetermined price for a future date. Under ESOPs, employees either buy stocks of their company at below market value rates or are provided stocks in lieu of remuneration upto a specific percentage. ESOPs are allocated in a phased manner, especially post a funding round. There is no limit on the quantum of ESOPs to be issued to the employees.
Why are ESOPs given?
ESOPs are a motivator and possible source of wealth for employees. It helps build employee trust by making them a part of the company’s growth journey. As new-age companies leap into the next trajectory of their growth journey, sustainable performance becomes highly dependent on the hard work, dedication and commitment of their employees. Therefore, in order to engage and motivate their employees to continuously create value, they reward them appropriately through sharing the benefits of value so created and enjoy the benefits of phenomenal growth that the companies foresee in the coming years. Along with salary, nowadays companies are also providing ESOPs that could be considered as extra monetary rewards for the employees.
Companies that provide ESOPs have long-term goals in mind. Companies not only want to keep their employees for the long term, but they also want to turn them into shareholders. ESOPs help employees in their personal wealth creation.
What are the tax implications of ESOPs?
For the employers (issuer of ESOPs)
Companies have no tax liability, it has to book Compensation Cost in its P&L Account
For the employees (recipient of ESOPs):
While exercising: Taxed as perquisite; the difference between the Fair Market Value (FMV) on the day of exercise and the exercise price is taxed as a perquisite in the hands of the employee when he/she exercises the option. This perquisite forms the part of total income from salary, TDS is applicable based on the salary bands.
While selling: Taxed as Capital Gains. After allotment and purchasing shares, if an employee decides to sell the shares, he/she shall be subject to Capital Gains tax if he sold these shares for more than FMV on the exercise date. Capital gains would be taxed based on how long they were held which is from the date of exercise to the date of sale.
Restructuring Modes Under ESOP
Employee Stock Ownership Plan (ESOP)
Offered by a company to its employees to take equity shares of the company at a discounted price.
Employee Stock Purchase Plan (ESPP)
Allows employees to purchase company’s shares, often at a discount from Fair Market Value.
Restricted Stock Units (RSU)
The employee is awarded the shares subject to fulfilment of certain underlying conditions
Stock Appreciation Rights (SAR)
Stock Appreciation Rights -Cash Settled (SAR-Cash Settled),
Stock Appreciation Rights – Equity Settled (SAR – Equity Settled)
In the case of SARs, an employee gets the benefit in the form of cash/equity which is the difference between the date of grant and final exercise of options.
Further details on ESOP will continue.