• The Employee Stock Ownership Plan (ESOP) is a system of an organization that allows individual employees to purchase shares of the organization.
  • The employees are given an option to buy the stock below the market value of the stock of the organization or the employee is provided a certain percentage of his/her remuneration in stocks of the company. The rights given to the employees under this scheme are called stock options. Those options include free company shares or at a concessional rate or at a predetermined price as per the potential market rate.
  • The employer has sole discretion in choosing the employee for availing this option. In some instances, the foreign company also grants this technique to its subsidiary company in India.

Why ESOP System was introduced

  • The motive behind this scheme is to boost up start-up companies in which employees do not get huge salary packages. But on the other hand, start-ups are willing to share the future profitability of the company. So, the employees are provided with stock options in the form of a compensation package. Whereas, in some cases, the employee is also granted stock options that he can use in the future date for the long-term commitment of the employee.
  • ESOP helps in creating a perception of belonging ownership amongst the employees apart from the monetary benefits.

Tax perspective

  • There are generally two stages in which the tax is implicated.
  • In the first step, the employee willing to purchase the shares at the initial price, and in another stage, the shares are ultimately sold to the employee.
  • In the first stage, when ESOPs are initialized, the difference between the initial price and value of the security shall be treated as a pre-requisite in the possession of the employee. In return, the employer is needed to deduct tax on the employee’s purchase of shares.
  • The value of the shares allotted to the employees shall be the average market price on the date the shares are allotted and according to the shares listed by Stock Exchange in India. If the shares are not listed at the market value, then the same shall be obtained from the merchant banker as per the valuation certificate.
  • The certificate of valuation of shares shall be not old than 180 days from the purchase of shares by the employee.
  • The company shall obtain the certificate from the Merchant Banker if the shares are listed outside India.
  • While discussing the International perspective, the ESOPs that are granted by the foreign companies to the Indian resident shall be taxable under India.
  • In order to understand better, the double taxation avoidance agreement shall be looked into as per the taxation provisions of the Country and the company for the exact tax implication. The concessional tax on long term capital gains as per the Section 112A or concessional rate of 15% tax on short term capital gain in respect of such shares would not be sold on Indian stock exchanges as these are not likely to be listed in India.
  • The criteria for granting ESOPs is to keep employees motivated and engaged in the business. This feature is not for every employee of the company. The company shall find out the most eligible employees through a selection procedure to avail of this scheme.

How to issue ESOP

  • The first step is to prepare a list of eligible employees for ESOP Scheme and defining their roles and duties.
  • The policy shall be drafted containing all the pre-requisites relating to ESOP such as
  • Employees selection and evaluation criteria for participating in the scheme
  • Rights of the shareholder-employee
  • Terms and conditions for exiting and other tax liabilities
  • The Board meeting shall be organized for the approval of the shareholders.
  • For the approval of the ESOP scheme, e-from MGT-14 shall be duly filled and signed by all the companies by attaching a Special Resolution for approval of Scheme.

When a share can be sold?

  • For selling the shares, two things shall be kept in mind such as capital gains implication and the need for liquidity to arrive at a conclusion.
  • However, it also depends upon the future aspects of the company and those shares that are acquired under the ESOP system. In these circumstances, the shares cannot be sold until the same has been listed or promoters willingly offer an exit which may not be on the good terms.

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