ESOP, also known as Employee Stock Ownership Plan, is an employee benefit plan that gives the employees an ownership part in the organisation that they work for. ESOPs are typically structured in various forms, including direct stock ownership, profit-sharing plans, or bonuses.
To implement an ESOP policy, employers must adhere to defined rules and regulations outlined in the Companies Rules. This makes sure that the process of giving out ESOPs is done in a way that follows all the legal rules. ESOP registration is frequently used as a way to motivate employees, get them on the same page with the company’s success, and encourage them to stick around.In this article, we shall see all about Employee Stock Ownership Plans in India.
Benefits of Employee Stock Ownership Plans in India for Employers
Employee Stock Ownership Plans in India offer a range of advantages to employers, extending beyond mere financial incentives. Mentioned below are the various benefits that ESOPs provide to organisations:
1. Motivation and Enhanced Performance
ESOPs serve as powerful motivational tools for employees. By offering stock options, employers create a direct link between an employee’s performance and their financial gain. When company share prices rise, employees reap the rewards, motivating them to excel in their roles and contribute their best efforts.
2. Employee Retention
Employee Stock Ownership Plans in India play a crucial role in holding onto valuable talent. When employees have stock options that they’ve vested in, they tend to stick around for the long haul because their success becomes tied to the company’s success. This helps cut down on the number of employees leaving and the costs that come with finding and hiring new folks.
3. Recognition of Hard Work
ESOPs provide a tangible way to recognise and reward hard work. Exceptional employees can see the direct impact of their contributions on the company’s stock value, reinforcing a culture of meritocracy within the organisation.
4. Attracting Top Talent
Employee Stock Ownership Plans in India can be a competitive advantage in the recruitment process. Prospective employees are often drawn to organisations that offer participation in ESOPs as it aligns their interests with the company’s success, making them more committed and engaged. By implementing ESOPs, organisations can cultivate a more engaged, loyal, and high-performing workforce while also achieving their business objectives.
Costs Associated with ESOPs and Distribution Methods
Employee Stock Ownership Plans in India involve various costs during their establishment and ongoing administration. Additionally, ESOP distributions can occur in several ways, depending on employee choices. Given here is an overview of these aspects:
1. Initial Costs of Employee Stock Ownership Plans in India
When implementing an Employee Stock Ownership Plans in India, there are several initial costs to consider, including:
- Professional Fees: Engaging professionals like StartupFino to draft the ESOP plan and ensure compliance with relevant regulations incurs legal fees.
- Accounting Fees: Accurate accounting and financial reporting are crucial for ESOPs. Accounting fees cover the cost of valuing the company’s shares and managing the ESOP’s financial aspects.
- Administrative Expenditures: The day-to-day administration of the ESOP and compliance with regulatory requirements, involves administrative costs.
These costs are typically borne by the company as part of its commitment to providing employee ownership.
2. ESOP Distribution Methods
ESOP distributions in India can occur through various methods, and employees have choices regarding what to do with their ESOP shares:
- Immediate Sale: When an employee exercises their stock options to acquire shares, they can choose to sell them immediately.
- Long-Term Holding: Alternatively, an employee can decide to hold onto the acquired shares for potential future appreciation. In this case, they become shareholders in the company and may benefit from:
- Dividends: When the company shares out dividends, ESOP shareholders might get a piece of it based on how much of the company they own.
- Capital Gains: If the company’s stock price goes up over time, employees who hang onto their shares can make a profit when they eventually sell them.
Employee Stock Ownership Plans in India involve initial costs related to legal, accounting, and administrative expenses. Employees can opt for immediate sale of ESOP shares, receiving proceeds minus taxes, or choose to hold the shares for potential future benefits such as dividends and capital gains. Understanding these costs and distribution options is essential for both employers implementing ESOPs and employees participating in them.
ESOP Taxation: Understanding the Dual Tax Effects
Employee Stock Ownership Plans in India come with a dual tax impact, affecting employees both when they exercise their rights to purchase company stock and when they eventually sell the acquired shares. The tax treatment at each of these stages is:
Tax Treatment at the Time of Buying Shares
When employees exercise their ESOPs and purchase company shares, the taxation process comes into play. This step is about looking at the gap between the Fair Market Value of the shares on the exercise date and what the employee pays to get them. Mentioned below is the breakdown:
- The gap between the FMV and the exercise price of the share is seen as a kind of asset owned by the employee.
- This difference is subjected to taxation at the individual’s applicable income tax slab rate.
It’s worth noting that in the case of ESOPs granted by new businesses, the government has introduced favourable tax provisions to ease the tax burden on employees:
- Employees at startup companies do not have to pay tax on the ESOP benefit in the year of exercise.
- Tax Deducted at Source on ESOPs is deferred until the earlier of two events:
- Five years from the date of the ESOP grant.
- The date of the employee’s departure from the company.
Tax Treatment at the Time of Selling Shares
The tax implications continue when an employee decides to sell the ESOP-acquired shares. The key factor here is the difference between the selling price and the FMV of the shares on the date when they were originally exercised. Here’s how this is handled:
- If an employee sells the shares within a year of acquiring them, any profits exceeding Rs. 1 lakh are subject to a 10% tax.
- In the case of shares sold within 12 months, the profits are taxed at a slightly higher rate of 15%.
For those dealing with foreign ESOPs in India, the tax treatment remains largely similar. Employees are liable to be taxed in India on the perks earned from a foreign company’s ESOPs.
Final Thoughts
Employee Stock Ownership Plans in India are a valuable tool used by organisations for several strategic purposes. ESOPs incentivise and retain talent, align employee interests with company success, and reduce attrition. They involve initial costs, including legal, accounting, and administrative expenses, and provide employees with various distribution options, from immediate sale for cash liquidity to long-term holding for potential dividends and capital gains.
Additionally, ESOP taxation has a dual effect, impacting employees when they exercise their options and when they sell shares, with favorable provisions for startup companies. Furthermore, when a company goes public, ESOPs become more liquid and benefit from market-driven valuations, enhancing their appeal to employees as a compensation and wealth-building tool.
