A Brief on ESOPs
Employee stock option scheme (‘ESOPs) becoming a popular way of attracting and retaining talent, the workforce is the lifeline of any corporate and with different rewards options, ESOPs become important part and parcel of the employee compensation plan, equity-based reward not only work as perks towards the employees while add sense of ownership of the organization for which they are working.
In IT sector, ESOP becoming popular choice since early 2000s and then, Pharma, retail & startups , slowly Banks & other financial services entities also adopting ESOP to attract and retain good talent.
While For Unlisted companies there is no open market available and only buy back remain option based on valuations, for listed companies SEBI (SBEB & Sweat Equity Shares Regulations),2021 as amended prescribed conditionalities for granting and allotment of ESOPs.
The Life Cycle of ESOP commenced from identifying the employees and granting of option and post completion of period of vesting the exercise of option by the employee by paying the prescribed exercise price to the company.
When reference is drawn towards SEBI regulations, the Prohibition of Insider trading (PIT regulations) come into picture, its pertinent to note that exercise of option is specifically excluded from the acquisition criteria and trading window closure prohibitions. It means any employee who has been identified as Designated Person due to functional role can exercise ESOP, subject to internal policies of the company.
Pre- clearance provisions and disclosure under Regulation 7 will be applicable if trading turnover exceeds prescribed threshold In Quarter.
ESOPs can be implemented either through direct route (new allotment) or through trust mechanism (if acquisition is from secondary market or gift is involved).
Implementation of ESOP for listed company required valuation report from registered valuer, appointment of merchant banker till in principal approval stage and approval of scheme through special resolution by shareholder.
While Regulations are silent after the minimum vesting schedule of One Year and on lock in, however the inherent nature of ESOP is to attract and retain talent. Its generally spread over 3 yrs to 5 yrs timeline.
Tax on ESOPs
While taxation is important for any country, but its always a demand from individual taxpayers to reduce the tax burden on ESOPs ,while Phantom stocks attracts only single point of taxation which is not the same in case of ESOPs.
As per the Income tax act ,1961, the exercise of ESOP is first point of taxable event in which difference between Fair Market Value and Exercise price attracts Perquisite tax and further sale attracts either 20% tax rate on short term gain or 12.5% on long term capital gain beyond 1.25 Lacs. * according to new tax regime
The annexed Excel sheet will help you to understand the perquisite calculation and tax payable on exercise of ESOP with quick snap of pre and post ESOP exercise tax impact and Break-Even Price.
The tax part is calculated as per Finance Act 2024 (New Tax Regime Only)
Disclaimer: Please note that the law is subject to constant change and any reference made in the above write up is only with an intention to give brief understanding of Employee stock option plan and relevant highlight of legislation, the calculations in the annexed excel sheet is only for understanding purpose and could not be relied upon for taking any kind of decision.
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