Introduction

An ESOP (Employee Stock Ownership Plan) is a type of employee benefit plan that gives employees a share of the company’s ownership. Employee stock ownership schemes come in the form of direct shares, profit-sharing plans, or incentives, and the employer has ultimate control over who is eligible to participate. Employee stock ownership plans, on the other hand, are simply options that can be purchased at a set price before the exercise date. The Companies Norms establish the rules and restrictions that firms must follow when awarding Employee Stock Ownership Plans to their employees.

How ESOPs work?

The number of shares to be offered under ESOPs, their price and the employees who would benefit are all decided by the employers. Employees are then awarded ESOPs, with a grant date specified. When you exercise your option, the lower the grant price, the better your chances of making a profit. In the case of start-ups, the grant price could be the unlisted stock’s face value or a merchant bank’s valuation as determined by the SEBI. The grant price for publicly traded firms is calculated using the average stock price over a period of time prior to the issue date.

After an ESOP is offered, it is held in a trust fund for a length of time known as the vesting period. To take advantage of the ESOP, employees must stay with the company for the vesting period.

Employees have the right to exercise their ESOPs after the vesting period has passed. The vesting date is the date on which the vesting period ends. Employees can use their ESOPs to purchase company stock at predetermined prices that are lower than market value. Employees can potentially profit from their ESOP investments by selling the shares they purchased. If an employee leaves or retires before the vesting term, the company is bound to buy back the ESOP within 60 days at fair market value.

Uses of ESOPs

• To buy the shares of a departing owner: Private-company owners can employ an ESOP to generate a ready market for their stock. The employer can either make tax-deductible cash contributions to the ESOP to buy out an owner’s shares or have the ESOP borrow money to buy the shares under this technique.
• To borrow money at a lower after-tax cost: ESOPs are one of the few benefit plans that can help borrow money. The ESOP borrows money to buy company stock or existing shareholders’ stock. The company then makes tax-deductible contributions to the ESOP to repay the debt, which includes both principal and interest (deductible).
• To create an additional employee benefit: The value of new or treasury shares issued to an ESOP can be deducted from taxable income. Alternatively, a company can make a monetary contribution by purchasing existing public or private stockholders’ shares. ESOPs are frequently utilised in conjunction with employee savings plans in public businesses. Rather than matching employee savings with cash, the company will do so with stock from an ESOP, often at a higher level of matching.

Tax implications of ESOPs

• Options provided by the company are not taxable.
• Vested options are not taxable.
• When an employee exercises the option of buying shares, the difference between the market value of the shares and the exercise value of the share will be taxable according to the tax bracket the employee falls under.
• When an employee sells the shares it is considered capital gains. If the employee sells the shares within one year 15% tax is levied against the capital gains. If the employee sells the shares after one year they are considered long term assets and are not taxable.
• If an employee has ESOPs in a company based abroad, when the shares are sold it will be considered short-term capital gains and will be added to the income of the employee. The employee will be taxed according to the tax bracket he/she falls into after that.
• If capital gains are long term, 10% tax will be levied without the benefit of indexation or 20% tax will be levied with the benefit of indexation.

Limitations of ESOPs

Over time, the ESOP may become a legal obligation for the company. These shares do not have an option premium, and the only remuneration that the company receives is in the form of greater venture liquidity and tax savings. Because the employee may or may not exercise his option at the expiration of the period, ESOPs carries a considerable level of risk, which is normally higher than standard stocks. The company receives cash only when the employee exercises his option, and the quantity of that liquidity is unknown until the exercise date.

When offered by a firm, ESOPs are tax-free. Employee stock options are also exempt from taxation. When an employee exercises his options, the difference between the market value of the shares and the exercise value of the shares is subject to taxation under the employee’s tax bracket. Also, if he sells the shares and makes a profit, that profit is taxable, depending on how long the employee has had the shares and whether the profits are deemed short-term or long-term capital gains.

REFERENCES

• https://cleartax.in/s/esop
• https://www.nceo.org/articles/esop-employee-stock-ownership-plan
• https://www.taxmann.com/post/blog/640/esop-advantages-and-disadvantages/
• https://www.bankbazaar.com/tax/employee-stock-option-plan.html

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