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Author - Associate Kantika Mukherjee

An ESOP (Employee stock ownership plan) refers towards an employee benefit plan which provides employees with an ownership interest in the corporation. Employee stock ownership plans can be issued as direct stock, profit-sharing plans or bonuses, and the employer has the discretion in determining who would avail these options.

Though, Employee stock ownership plans are only options that can be purchased at a stated price prior to the exercise date. There are distinct rules and guidelines specified in the Companies Rules which employers are required to follow for giving Employee stock ownership plans towards their employees

Why an employer offers ESOP to their Employees?

Corporations often make use of Employee stock ownership plans as a medium for attracting and retaining high-quality workers. Corporations generally distribute the stocks in a phased way. For example, a corporation might grant its workers the stocks at the close of the fiscal year, in that way offering its workers an incentive for remaining with the corporation for receiving that grant.

Corporations giving ESOPs have long-term goals. Not only corporations attempt to retain workers for long-term but also aims to make them the stakeholders of their corporation. Many firms in their startup stage provide out stock options to their workers in return for the high salary that they receive. This decreases the total cash outflow with limited resources. ESOP make certain that workers at every level of the corporation attempt to work at optimum levels towards boosting the corporation’s growth.

Corporations giving ESOPs not just want to retain valuable employees for a long time but also aim at making them stakeholders in the corporation also. By means of offering a stake in their business, companies turn their compensation packages more attractive as well as competitive.

Benefits of ESOPs for the employers

Stock options are offered by a corporation as a motivation towards its workers. As the employees like to get benefitted when the corporation’s share prices rise, it shall be an incentive for the worker to give his 100%. The key benefits are;

A corporation can use ESOP to obtain the shares of a departing owner. The proprietor of private corporations could use ESOP for selling their shares in the corporation. These choices are a somewhat tax-deductible option provided by a corporation to its workers.

Also, corporation might use ESOP for borrowing money at lower after-tax cost. ESOP can be used to purchase a corporation’s shares or shares of its existing members. The contribution to the ESOP is tax-deductible as they are utilized towards repaying the amount of the loan of the corporation.

Through the help of ESOP options, corporations can avoid the cash compensations as a reward, therefore saving on immediate cash outflow. For corporations which are starting their business processes on a bigger scale or expanding their business, awarding their workers with ESOPs shall exercises to be the most viable option than the cash rewards.

Eligibility

Apart from the directors and promoters of a corporation who have above 10% equity in the corporation, every employee is entitled to ESOP. Though, an employee is required to meet a few criteria.

• A full-time or part-time Director of the Corporation.
• A current worker of the Subsidiary, Associate or Holding located anywhere in India, or overseas.
• A permanent worker working in an Indian or Foreign office of the corporation.

Types of ESOPs

The types of Employee Stock Option Plans that are offered to employees by an employer are:

• Employee Stock Purchase Plan (ESPP)
• Employee Stock Option Scheme (ESOS)
• Phantom Equity Plan(PEP)/ Stock Appreciation Right (SAR)
• Restricted Stock Award (RSA)
• Restricted Stock Unit (RSU)

Tax Implications

There are two tax implications for ESOPs, they are:

When exercising – in the form of a precondition. An employee, when executes his option, the difference between the Fair Market Value (FMV) as on the date of exercise and the exercise cost is taxed as a prerequisite.

When selling – in the form of capital gain. An employee can sell his shares after purchasing them. If he sells these shares at a charge which is higher than FMV on the exercise date, the individual shall be liable for capital gains tax.

Capital Gains

The capital gains shall be taxed reliant on the period of holding. This period is calculated from the date of exercise until the date of sale. The Equity shares which are listed on the recognized stock exchange are taken as long-term capital if they are held for above 12 months. If the shares are sold in 12 months, then these are considered as a short term. At the moment, long-term capital gains (LTCG) on the listed equity shares are exempted from tax. Though, according to the recent amendments in Budget 2018, Sale of equity shares which are held for above a year on or after 1st April 1, 2018, shall attract tax at 10% and cess of 4%. Short-term capital gains (STCG) are taxed at 15%.

Tax on Foreign ESOPs

In case an employee holds foreign shares, they are considered the same as unlisted shares and taxed, reliant on the duration the shares are held, LTCG or STCG. This shall be included as a part of their income and shall be taxed according to the relevant tax bracket.