ESOP and its tax implications - Finance Ppl

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ESOP and its tax implications

What is an ESOP?

An Employee Stock Option Plan is a scheme where a company grants employees the right to purchase shares at a predetermined price, after an initial vesting period.

Purpose of issuing ESOP

Listed companies, Unlisted companies and eligible startups were allowed to issue ESOP to its employees. To reward employees and retain talent, and align their interests in company's growth.

When was ESOP introduced in India?

In 1999, SEBI introduced the Employee Stock Option Scheme & Employee Stock Purchase Scheme Guidelines 1999, which provided the first formal regulatory framework for listed companies. Later in 2014, SEBI replaced rhese guidelines with Share Based Employee Benefits Regulations 2014 updating the rules for issue of ESOP by public companies.

Who is entitled to ESOP?

ESOP can be issued to Employees of the company,including directors. ESOP cannot be issued to independent directors.

Exclusions: ESOP can't be alloted to promoters or those already holding more than 10% equity shares.

Issue Terms & Conditions

Following are the terms and conditions of issue of ESOP:

  1. Vesting period:

    Employee must wait for minimum period of 1 year after grant of options, before they become eligible to exercise those options.

  2. Exercise price: The exercise price must be fixed at that stage itself when options are granted. Listed companies must disclose this in accordance with SEBI guidelines.
    Companies may set concessional exercise prices to make ESOPs attractive.

    3. Exercise period is the time window to convert options into shares. Company must specify the exercise period in the offer document. options that are not exercised within the exercise period lapse.

  3. Lock-in conditions: Company shall specify lock‑in conditions in the ESOP scheme. The lock‑in period is the minimum time employees must hold the shares after exercising their options before they can sell or transfer them.
Subsequent Period Conditions

Post-exercise, shares can be sold subject to company/market restrictions.

Tax Implications

There are two taxable events:

  1. At Exercise (Perquisite Tax)

    2. ESOP exercised is taxed as part of salary income and the Employer deducts TDS. For eligible startups, tax payment can be deferred.
    Value = Fair Market Value on exercise date – Exercise Price.

  2. On Sale of the shares

    3. Capital Gains shall apply on sale of the shares. Sale price – FMV = Capital Gain.