Employee Stock Ownership Plans, or ESOPs, are employee benefit plans that give employees a stake in the company. These plans are intended to match employees’ interests with those of shareholders by providing employees with a stake in the company’s success. Employee stock ownership plans (ESOPs) can take numerous forms, but they often involve employees acquiring shares of the company’s stock.
Employee stock ownership plans (ESOPs) can be a useful instrument for aligning employees’ interests with those of the company and promoting a sense of shared ownership and accountability. However, they may not be appropriate for every business and must be carefully considered.
Let’s understand the Pros and cons to it
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Pros of ESOPs:
Employee Engagement and Motivation: ESOPs can encourage employees by providing them with a direct stake in the company’s performance and success. Employees may be more engaged and devoted to the company’s aims if they believe they are working for their personal advantage.
Recruitment and Retention: Offering an ownership part through ESOPs can be a great strategy for maintaining existing talent and attracting new employees. It cultivates in employees a sense of loyalty and devotion.
Tax Benefits: ESOPs can give tax advantages to both the corporation and the employees. Contributions to the ESOP trust are frequently tax-deductible for the corporation, and employees may receive shares without paying taxes on them until the shares are sold.
Succession Planning: For business owners wanting to exit or retire, ESOPs can be a beneficial tool. It provides a framework for employees to transfer ownership, assuring continuity and potentially preserving the corporate culture.
Increased Productivity: According to some research, organizations with employee ownership models are more productive, probably because employees are more driven and feel a larger sense of responsibility for the company’s performance.
Cons of ESOPs:
Lack of Diversification: Employees who earn shares through an ESOP may become overly invested in their own company, resulting in a lack of diversification. If the company performs poorly, it might cause financial difficulties for employees, who may see the value of their retirement funds diminish.
Complexity and cost: Creating and sustaining an ESOP can be complicated and costly. The costs of adopting and operating an ESOP include legal, administrative, and valuation fees.
Limited Liquidity: Employees may find it difficult to sell their shares, especially if the company is private. Employees who require cash or want to diversify their investments may be hampered by a lack of liquidity.
Risk of Poor Company Performance: If the company performs poorly, the ESOP shares’ value may fall. Employees’ retirement funds and morale may suffer as a result.
Communication Difficulties: It can be difficult to effectively communicate the details of an ESOP to employees and ensure they understand the implications. Employee misunderstandings and unhappiness may result from a lack of communication.
Companies seeking ESOPs must carefully examine the merits and cons, considering their specific circumstances and staff preferences. Consultation with legal, financial, and human resources professionals can assist in decision-making.
Taxation of ESOPS:
There are two situations in which an employee’s ESOP is taxed. The first is when they are exercised, and the second is when the shares are sold. In the first instance, it is considered a perk and is taxable as income under the head salaries. When sold on the market, the second instance is treated as a capital gain.
Is there a tax difference between listed and unlisted shares? According to the expert, there isn’t much of a difference in terms of perquisite tax. When listed shares are allotted, the tax is calculated based on the traded price on a stock exchange, whereas unlisted shares require the merchant banker to ascertain fair market value.
One thing to keep in mind is when one would be required to pay taxes. ESOPs are taxed in the year that the options are exercised, and the taxes must be paid in that year. In the case of start-ups, however, additional time has been allowed for the deposit of such ESOP. Employees have four years from the end of the assessment year in which shares are allotted, or the date on which the shares are sold, or such person ceases to be an employee of that company, whichever is earlier, to pay their tax liability.”
Let’s understand the tax Implication with the help of Example: –
Mr. Y was offered shares of his employer’s company for Rs.75 per share. Mr. X
Exercised the options. On that date FMV was Rs.115 per shares. After the shares were allotted Mr. Y sold the shares within 2 months for Rs.160 per shares. Give tax implications?
1. On allotment of shares there will be Perquisites (Taxed under the head of Salaries)
Value of perquisites = FMV – Cost to employee =115*1000 -75*1000 =40000/-
Hence the Value of perquisites = 40000 Rs. Added in salaries of Mr. Y taxed at per tax slab applicable.
2. On sale of shares there will be a capital gain taxed under the head of capital gain (It will be short term capital gain as its sold within 2 months)
capital gain = sale consideration – cost of purchase
= 160*1000 – 115*1000
= 45000/-
Hence capital gain will be added in income of Mr. Y taxed at as per tax slab applicable.
Mr. Y bought 1000 shares, cost of acquisition 100/-per shares and sold for traded price on a stock exchange 110/- (Note STT paid at the time of sale and purchase)
capital gain would be calculated as per section 111A of the Act, as shares are listed and STT is paid on such shares.
capital gain = sale consideration – cost of acquision
= 110*1000 – 100*1000
= 110000 – 100000
=10000
tax amount = 10000 *15% = 1500/-
Employee stock ownership plans (ESOPs) can benefit both employees and organizations by building a culture of shared achievement and producing a more resilient, engaged workforce. To attain their full potential, ESOPs, like any sophisticated financial plan, require careful research and successful implementation.
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The above article is written by Ms. Laxmi Malage (Laxmikmalge123@gmail.com) and reviewed by Mr. Suyash Tripathi (suyash.tripathi@abacussolutions.co.in)
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