How do ESOP works – Employee Stock Option Plan

How do ESOP works - Employee Stock Option Plan

How do ESOP works – Employee Stock Option Plan


Meaning of ESOP (Employee Stock Option Plan)

It’s an Employee benefit plan which is intended to encourage employees to acquire stocks or ownership in the company led to the emergence of the concept of Employee Stock Option Plan (ESOP).

How do ESOP works?

ESOP is a form of remuneration for employees. It’s a reward for loyalty, performance or tenure with the company. When an employee gets ESOPs from the company where he/she works, he/she gets the right to purchase a certain number of shares in the company at a predetermined price after a predetermined period or periods. Employees consider ESOPs, a perk of working in a good company or perk of working for a long tenure or a form of appreciation. However, ESOPs have intricacies and legal framework associated with these stock options. Compliance to ‘The Companies (Share Capital and Debenture) Rules, 2014’ (‘Company Rules’) govern the grant of stock options has to be ensured while issuing ESOPs.

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What kind of employees are actually entitled to ESOPs

As per Company Rules, only

(i) a permanent employee working in or outside India;

(ii) a whole-time or part-time director of the company; and

(iii) an employee of a subsidiary, holding or an associate company working in or outside India, can claim benefits under an ESOP scheme.


NOTE:  A ‘promoter’, or a director holding >10% of the equity shares of the company are not entitled to take part in this scheme.


Tax implications on ESOPs

– When the options are given by the company, there is no tax.

– When the options get vested, there is no tax.

– Tax is payable on the value arrived as the difference between the market value and exercise value. The difference value is treated as perquisite i.e. salary income and is taxable as per the tax bracket that the employee falls in.

– When the employee sells the shares, the profit is treated as capital gains. If the shares sold within one year, 15% capital gains tax has to be paid just like in the usual purchase and sale of shares. If the stock is sold after 1 year, there is no tax as it is considered as long-term.

– If the employee has ESOPs of a company that is listed abroad and sells the shares, short-term capital gains is added to income and one has to pay tax as per the tax slab that he/she falls into.

–10% tax (without indexation) or 20% tax (with indexation benefit) has to be paid if the capital gains are long-term.


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