Employee stock option plan (ESOP) refers to the employee benefits scheme under which the employees are allowed to purchase the shares of their company. Most of the Indian and multinational companies use ESOPs as a compensation tool. The company encourages the employees to acquire firm ownership by offering the shares at a below-market rate in order to increase their involvement in the scheme. In many cases, the companies in India also offer the stocks as remuneration up to a specific percentage to employees. The compelling reasons for companies to implement ESOPs include wealth creators for its employees and retention. It also provides a measure of employee ownership in a high growth environment.
ESOP is essentially an incentive, granted to an employee, director or officer to buy or subscribe to the shares of the company at a pre-determined price in the future. In this way, grantees are offered equity compensation instead of / in addition to the remuneration. The benefit of ESOPs is that it allows grantees to have a stake in the company which directly results in greater loyalty and motivation while aligning the incentives of various stakeholders.
Permanent employees, directors and officers are eligible to receive an option under an ESOP scheme. However, the following individuals are not eligible to participate in the scheme:
- An independent director,
- An employee who is a promoter or belongs to the promoter group, and
- A director who directly or indirectly holds more than 10% of outstanding equity shares.
The company granting an option under ESOS (Employee Stock Option Scheme) has the freedom to determine the exercise price subject to accounting policies and regulations. The pre-determined price at which an employee can exercise the option is called strike price or exercise price. If the price of the stock increases, the employee gains at the strike price, which is below the current stock price. However, if the stock goes down, the option will be worthless. Employee benefits from the gains when the stock price rises but loses nothing in case strike price is higher than current stock price.
Compliance requirements for issuance of ESOP
Below mentioned are the compliance requirements for issuance of ESOP:
- Approval of shareholders shall be obtained by passing a special resolution
- The company shall make the following disclosures in the annexure to the notice for passing a special resolution:
- Total number of stock options to be granted
- Identification of classes of employees entitled to participate in the ESOS
- Appraisal process for determining the eligibility of employees to the ESOS
- Requirements of vesting period and period of vesting
- Maximum period within which the options shall be vested
- Exercise price and the formula for arriving at the same
- Exercise period and process of exercise
- Lock-in period, if any
- Maximum number of options to be granted per employee and in aggregate
- The method which the company shall use to value its options
- The conditions under which option vested in employees may last, for example, in case of termination of employment for misconduct
- Specified period within which the employee shall exercise the vested options in the event of a proposed termination of employment
- A statement to the effect that the company shall comply with the applicable accounting standards
- The company shall obtain approval of shareholders by passing a separate resolution in case of
- Grant of option to employees of subsidiary or holding company
- Grant of option to identified employees, during any one year, equal to or exceeding 1% of the issued capital of the company at the time of grant of option
- The company may vary the terms of ESOS not yet exercised by the employees by passing a special resolution, provided such variation is not prejudicial to the interest of the shareholders.
- The company shall maintain a Register of Employee Stock Options in Form SH-6.
Taxation of ESOP
The value of the employee stock option is taxable as a perquisite in the hands of the employee. The value of the ESOPs is calculated as Fair market value (FMV) of shares on the date of exercise less the Exercise price actually paid by the employee
Capital gains tax on ESOP
On the date of sale of shares the difference between FMV and strike price shall be taxed as capital gains.
In conclusion, ESOP acts as an incentive for an employee to invest in company’s growth. It creates a sense of ownership in the employee for the company, thus, encouraging greater productivity.
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