Employee Stock Ownership Plan

Over the past decade, it is common to see various companies offering shares in the company to their employees. Employee Stock Ownership Plan, or most commonly known as ESOP, refers to a particular employee benefit plan. This plan offers an employee with an ownership interest in the specific organisation they are employed in. Employee Stock Ownership Plans are often issued as profit-sharing plans, bonuses or direct stocks which would be availed by employees who are chosen at the sole discretion of the employer. We take a more in-depth look into Employee Stock Ownership Plan and its various aspects in this article.

Why is ESOP offered to Employees?

When an employee is offered shares in the very company that they are employed in, it gives them a sense of ownership. This motivates them to work with a vested interest in the overall growth and well-being of the company, which, in turn, increases the employee's productivity. It is common to see companies in their startup stage give out stock options to their employees in return for the high salary that they earn. This reduces the total cash outflow with the already-limited resources. ESOP ensures that employees at every level of the company strive to work at optimum levels to boost the company's growth. Companies often use ESOPs as a way of attracting and retaining great and potential employees. These organisations generally distribute stocks in a phased manner. For example, a company may grant its employees with stocks at the close of a financial year, and therefore, essentially offering their employees an incentive for being loyal and remaining with the organisation. Companies offering ESOPs typically aim for long-term objectives. They do not just seek to retain valuable employees for a long time but also intend on making them stakeholders in the company as well. By offering a stake in their corporate, they turn their compensation packages much more attractive and competitive.

Eligibility

Excluding directors and promoters of a company who have more than 10% equity in the company, every employee is eligible for ESOP. However, an employee should meet any of the following criteria.

A full-time or part-time Director of the Company.
A current employee of the Subsidiary, Associate or Holding located anywhere in India, or abroad.
A permanent employee working in an Indian or Foreign office of the company.

Advantages for Employers and Employees

The following are the benefits of the Employee Stock Option Plan from the Employer's and Employee's perspective.

Employer	Employee
The Employer shares the same interests with the Employee, which is to work together for the overall growth of the company.	Higher salary package
Creates a motivated workforce for the Employer.	Has immense growth in terms of wealth and wealth creation.
Cash reserves of smaller companies or startups are not affected.	Employee is offered the opportunity to participate in the decision making process of the company.
Increases the overall productivity of the company.	Offers a sense of job security and satisfaction for the Employee.
Improves the Employees trust in the company's management.	Creates a sense of ownership for the Employee.
Increases the loyalty of its Employees.

Types of ESOPs

A company offers ESOPs to its employees for purchasing a particular number of shares in the company at a pre-defined price after the option period, which is typically a certain number of years. Before an employee exercises their option, they need to go through a pre-defined vesting period. This means that the employee has to work for that specific organisation until a part or the entire stock option is exercised. The following are the types of Employee Stock Option Plans that are often offered to employees by an employer.

Employee Stock Purchase Plan (ESPP)

An employee may purchase shares below the market price, generally fixed at a discounted price, at grant/ exercise. The price and the date at which the employee may purchase the shares of the company is pre-determined by a plan term. This is known as the Employee Stock Purchase Plan (ESPP).

Employee Stock Option Scheme (ESOS)

Under the Employee Stock Option Scheme, the employee is not under any obligation but has every right to exercise shares, at a pre-determined price. The employee must ensure to complete a target or a specific tenure before vesting. Then, the employee may purchase the shares at the pre-determined price upon exercise.

Phantom Equity Plan(PEP)/ Stock Appreciation Right (SAR)

In a Phantom Equity Plan (PEP) or a Stock Appreciation Right (SAR), employees are offered shares of the company in theory, which the employee may obtain a cash value that is equal to the price appreciation over the grant price, once they achieve their vesting conditions.

Restricted Stock Award (RSA)

An employee is offered shares in the company along, certain voting rights and is entitled to dividends if the employee meets the pre-set conditions by the employer. However, if the employee fails to meet such requirements, then the employee is no longer eligible to obtain the company's shares. The conditions set by the employer may depend on a particular tenure or may refer to a specific target. The Restricted Stock Award may be bought at a cost that is lesser than the market value. Typically, there are no costs attached to the stocks. In cases of such ESOPs, the employee owns the shares from the very first day and is eligible to bonus and dividends during the vesting period.

Restricted Stock Unit (RSU)

The Restricted Stock Unit is very similar to the Restricted Stock Award. However, the difference lies in the fact that the employee has no voting rights nor has a right to dividends. The employee may only exercise the shares granted by the employer once the pre-determined conditions are met. Restricted Stock Units do not get transferred immediately to the employee. However, the employee may be entitled to partial dividends in the future or under specific circumstances.

Tax Implications

Generally, there are two tax implications for ESOPs. The first tax implication is when the employee exercises their right to purchase a company's shares. The second implication is when the employee is willing to sell their acquired shares.

First Tax Implication

When an employee chooses to exercise their option, the gain is added to their salary and is taxed by their employer. The value of the shares allotted for the employee is treated at an average value of the market value if the company is listed in India. When the company is not listed, then a certificate that estimates the market value of the allotted shares must be obtained from a merchant banker. Moreover, if an employee is offered shares of a listed foreign company, it is typically treated the same as an unlisted Indian company. Therefore, a certificate that estimates the market value of the allotted shares must be obtained from the merchant banker for this case as well.

Second Tax Implication

When an employee decides to sell their shares, they will be liable to capital gains taxes. The tax rate will depend on the duration the employee held on to their shares; accordingly, short-term or long-term capital (LTCG) gain taxes will be applicable. Moreover, it also depends on the fact that if the shares held by the employee are listed or not in India to estimate their liability to taxes. If the value of gains crosses the threshold of INR 1,00,000, listed shares that are held for more than 1 year with Security Transaction Tax (STT) is subject to 10% of LTCG tax. Capital gains taxes will not be applicable for gains that are valued less than INR 1,00,000. If the value of gains is less than INR 1,00,000, listed shares that are held for less than 1 year with Security Transaction Tax (STT) is subject to 15% of STCG tax. LTCG tax of 20% with indexation (10% without indexation) will be applicable if unlisted shares are held for more than 2 years. It should also be noted that any unlisted shares that are held for less than 2 years are treated as STCG and applies to taxes as per the relevant slab rate.

Tax on Foreign ESOPs

If an employee holds foreign shares, they are treated the same as unlisted shares and taxed, depending on the duration the shares are held, LTCG or STCG. Additionally, international taxation laws are to be studied by the employee and applied in order to avoid double taxation, according to the Double Taxation Avoidance Agreement (DTAA).