Employee Stock Option Plan (ESOP) in India

The Employee Stock Option Plan (ESOP) provides workers of a business the chance to acquire company shares at reduced prices or no cost following required vesting conditions. ESOP stands as a widely applied business method which startups and developing organizations use to drive staff performance and recruit talented executives while harmonizing worker objectives with organizational goals.

A corporate ownership opportunity through ESOPs enables workers to gain share ownership in their company so they become more dedicated and motivated in their work. Organizations usually provide these plans to their workforce as supplementary monetary benefits together with standard wages.

This article provides a thorough breakdown of everything related to Employee Stock Option Plans (ESOPs) in India.

What is an Employee Stock Option Plan (ESOP)?

When employees receive the right to purchase company shares at a set price lower than market value through an ESOP they receive this benefit plan. The employees typically must work for a predefined period before receiving stock options under this benefit plan.

Key Features of ESOPs

• Grant Price (Exercise Price): The price at which employees can buy the stock. This is usually lower than the market price.

• Vesting Period: The period of time during which the employee must wait before they can exercise their options. The vesting period typically ranges from 3 to 5 years.

• Exercise Period: The period during which an employee can exercise their option to buy the stock. This period may last a few years after the vesting period.

• Option Pool: A reserved amount of company stock set aside for future ESOP grants. The size of the option pool is typically determined by the company based on the number of employees and the percentage of ownership.

Types of ESOPs

• QESOPs are stock option plans which major public companies provide under SEBI Securities Exchange Board of India regulations. Companies listed at exchanges tend to use ESOPs because these plans include tax advantages.

• NQESOP are stock option plans that mainly target employees of private smaller businesses which do not trade on the stock market. Non-qualified plans provide adjustable programs however they differ from QESOPs by lacking tax benefits.

How Do ESOPs Work in India?

• Step 1: Granting of Options

1. Through stock option grants the company provides employees an opportunity to purchase a specified number of shares at a predetermined price after a minimum vesting period expires.

• Step 2: Vesting Period

1. After completion of the vesting period employees have the right to exercise their provided options. An employee who terminates employment during an unvested period will lose all stock options that remain unvested.

• Step 3: Exercising Options

1. The employee acquires their vested options as buying power to purchase shares at their predetermined exercise price even though the current price differs.

• Step 4: Selling Shares

1. After the shares are acquired, the employee has the option to sell them at the market price. Any profit made from selling the shares can result in capital gains, which are taxed as per the regulations in India.

Benefits of ESOPs

For Employees:

• Staff members receive financial benefits when their corporation experiences increased stock market value.

• Atlantic Health System provides employees with ownership rights because it fosters both worker engagement and organizational loyalty and motivational levels.

• The vesting schedule acts as motivation for staff members to maintain their employment at the organization for extended periods since stock options provide maximum benefits only with time.

• Long-term capital gain tax benefits become available to employees through stock sales that occur after specified time periods since their grant dates.

For Employers:

• ESOPs function as an essential tool for attracting qualified staff and retaining them both at startup businesses as well as at early-stage companies.

• Employees develop focused multiple interests in company success when they conduct a share purchase which creates better task execution and stops personnel from leaving.

• ESOPs operate as financial compensation methods that consume minimal cash flow so startups along with established organizations with limited funds benefit from them.

ESOP Taxation in India

The taxation of ESOPs in India is governed by the Income Tax Act, 1961, and tax treatment occurs at two key stages: when the options are exercised and when the shares are sold.

• Taxation at the Time of Exercise:

1. When an employee exercises their stock options (i.e., buys the stock at the exercise price), it is treated as a perquisite (a benefit or advantage) and is subject to Income Tax under the head "Income from Salaries." The taxable amount is the difference between the market price of the shares on the date of exercise and the exercise price paid by the employee.
2. For example, if an employee buys a share for INR 100 and the market price on the date of exercise is INR 200, then the taxable perquisite is INR 100 per share, which is added to the employee's taxable income.

• Taxation at the Time of Sale:

The employee will have to pay Capital Gains Tax on the profit from share sales after the exercise of stock options. The Capital Gains Tax rules apply depending on how long the employee holds the shares.

1. The tax rate for short-term capital gains (STCG) is 15% when the employee exercises stock options which results in selling shares within 36 months.

2. Long-term capital gains (LTCG) apply when employees sell their shares later than 36 months because they receive a 10% tax rate without indexation benefits.

ESOP Vesting and Exit Conditions

Vesting is a key component of the ESOP process, and it refers to the time period over which an employee’s options become available for exercise. If an employee leaves the company before the vesting period is complete, they will generally forfeit their unvested options.

• Exit Conditions: In the case of startups or private limited companies, an employee may also be subject to an exit clause, where they can sell their shares only when there is a public listing or acquisition of the company.

Regulatory Framework for ESOPs in India

The Indian regulatory framework which controls ESOPs consists of these key elements:

• SEBI implements guidelines to regulate the ESOP distribution process for listed companies focusing on disclosure standards as well as fairness requirements.

• The Indian Income Tax Department sets rules for ESOP taxation through the provisions defined by the Income Tax Act.

• Under the 2013 Companies Act there are rules that specify how businesses can distribute stock options to their workforce according to both corporate governance and legal requirements.

ESOPs in Startups

ESOPs demonstrate high popularity among startup companies. Startups normally encounter salary restrictions from their limited funding availability but they implement ESOPs to draw and maintain exceptional employees.

The growth of companies in startups allows workers to earn substantial ownership through ESOPs thus providing them extra motivation.

Conclusion

Employee Stock Option Plans (ESOPs) provide expanding organizations and their companies with an effective mechanism to reward their workforce and maintain staff retention. An ESOP serves to unite employee interests with company objectives and gives staff members the potential to obtain financial rewards from corporate growth.

Through ESOPs employees can build their wealth and feel ownership of the firm and employers can use them to recruit and inspire workers. The complete advantage of ESOPs requires employees to understand their tax implications and the required vesting schedule.

Indian employees should understand the tax rules for ESOPs along with their regulations before making stock option-related business decisions.

Disclaimer

The information provided in this blog is purely for general informational purposes only. While every effort has been made to ensure the accuracy, reliability and completeness of the content presented, we make no representations or warranties of any kind, express or implied, for the same. 

We expressly disclaim any and all liability for any loss, damage or injury arising from or in connection with the use of or reliance on this information. This includes, but is not limited to, any direct, indirect, incidental, consequential or punitive damage.

Further, we reserve the right to make changes to the content at any time without prior notice. For specific advice tailored to your situation, we request you to get in touch with us.