ESOP stands for Employee Stock Ownership Plan. It is an employee-owned stock which enables employees of an organisation to be owners of the organisation. It can be considered one of the incentives.

ESOPs make an employee feel he or she is a part of the company’s success story. Employees with a financial stake in the company are committed to and responsible for it. Additionally, when they own shares, they invest more in the company’s long-term performance.

ESOPs are not only useful to the employees but also to the company itself. They can be termed as a special employee benefit that benefits the company’s finances. ESOPs foster a culture of teamwork and responsibility, which catalyses excellence and success.

They are highly effective in maintaining employee motivation, engagement, and efforts toward organisational goals.

Section 2(37) of the Companies Act 2013 defines the term ESOPs.

It is a right granted to the directors, employees, or officers of a company, its holding or subsidiary company to purchase, enjoy, or subscribe for the shares of the company at a prescribed price on a pre-determined date.

ESOP, therefore is a scheme under which a firm attempts to increase its subscribed equity capital by issuing more shares to the employees of the company at a predetermined rate.

It’s a plan that benefits the employees as well as the company. The companies which are not listed on the stock exchange, requires to abide by the rules of the Companies Act, 2013, and Companies (Share Capital and Debenture) Rules, 2014.

The listed companies have to abide by the guidelines according to the Securities and Exchange Board of India (SEBI) Employee Stock Option Scheme Guidelines.

The ESOP is another form of alternative plan where some employees are permitted to purchase company stocks either directly or through contributions.

The allocated shares in the ESOP are usually totally subject to the vesting period. Employees will be able to gain more ownership rights based on a predetermined time schedule during the vesting period.

ESOPs are strictly for employees and include options which tied up with some conditions. Once the employees exercise ESOPs, they could become significant shareholders with voting rights and, possibly monetary advantages.

Additionally, conditions are usually set by the rules of ESOPs in order to avoid early sale or transfer of shares, which requires long-term commitment from employees and falls in line with the goals of a company.

ESOPs are special benefits to the employees. They do not extend to the promoters, consultants, advisors, freelancers, and contractual staff. They are not eligible to join in.

From the company, employees receive ESOPs as rewards based on their performance. Performance could be a means of measurement through any of the following: achieving revenues; introducing a new product; or advancing market growth.

The taxability of the ESOP transaction for employees occurs in two different situations, namely, upon purchase of the ESOPs and at the time of selling the ESOPs.

1. Upon exercise of the ESOPs by the employees to buy company’s shares

Employees may purchase at a price below Fair Market Value (FMV) as of vesting date. Any amount by which FMV exceeds the exercise price, it is considered a perquisite in hand of the employee and gets taxed at their slab rate of income tax.

However, the government has eased out tax implications on ESOPs for start-ups. No tax is charged on gratuity on the date of exercising the ESOP by start-up employees. Instead, TDS on ESOPs would be deductible by them by either of the following dates, whichever is earlier:

1. Completion of five years from the ESOP grant date
2. Date of selling the ESOP
3. Date of leaving the company

2. When employees sell their shares

In cases where the issued shares are sold, capital gains taxes apply on the difference between the selling price and the FMV during the date of exercising.

Capital gains tax applies based on a holding period that is treated as the period between the dates of exercising and sale of the ESOP.

If profit is earned out of selling the shares after holding it for 12 months, then a tax of 10% is leviable on the gains exceeding Rs. 1 lakh. However, if the shares are sold within 12 months, then the profit earned will be taxed at 15%.

ESOPs have benefits for both – the Employer and the Employee.

A) Benefits for the Employees

1) Buy Shares at a Discounted Rate

When employees exercise their ESOP, they normally pay a minimal price to acquire the shares allocated for them and are thus able to acquire a stake in the company at a favorable price.

2) Ownership of Equity

Under an ESOP, employees have the right to acquire a percentage of their stock whereby laborers can become partial owners of the company.

3) Dividend Income

Shareholder dividends are paid as a percentage of the profits that the company makes. Through such forms, workers can receive supplementary income in the form of dividends and directly benefit from the production of profits for the company.

B) Benefits to the Employers

ESOPs offer many benefits to the employer:

1) ESOPs are a great way to keep or retain employees: the period which must elapse before workers may exercise their ESOPs tends to make them want to continue working for the company.

2) ESOPs have been proven to enhance the employees’ productivity. Employees work towards the success of the company to receive benefits for ESOPs.

3) ESOPs form a worthwhile incentive for attraction and retention of quality human resources within an organisation, especially for start-ups that take long periods before offering attractive salaries in their early existence.

What is the vesting period?

The vesting period is the period when the employee gets his or her ESOPs and when he or she can entirely exercise the rights. It refers to the time that begins with when they acquire the ESOPs and ending at the time they are allowed to use all of their rights.

What is the minimum time period for vesting of ESOPs in India?

The minimum vesting period of an ESOP in India is one year.

Which individuals of a company are excluded from India for exercising an ESOP?

Consultants, advisors, freelancers, contractual employees, and promoters of the company are not eligible for availing ESOPs.

What are direct acquisitions of an ESOP Plan?

This is an option where the employees can buy the shares of the company directly without the interference of the broker or third-party agent. The company directly grants the equity shares with itself to its employees.

Which types of companies are eligible to avail of the ESOP in India?

Both listed and unlisted companies are eligible to avail of the ESOPs in India.

Which regulations are to be followed for the listed and unlisted companies in India to avail of the ESOPs?

The regulation for a listed company is governed by the SEBI Scheme Guidelines in India. The regulation for an unlisted company is governed by the Companies Act, 2013 and the Companies (Share Capital and Debenture) Rules, 2014.

What happens when the employee fails to exercise his/ her ESOP plan during the vesting period?

Employees are at their wish to either exercise or not exercise their ESOPs plan during the vesting period. In case they are not exercising the said option then they are not liable for the applicable taxes.

Whether ESOPs can be taken from the employee’s salary by the employer?

The ESOPs are not taken from the salary of an employee.

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