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Employee Stock Option Plan (ESOP)

HomeCompanyEmployee Stock Option Plan (ESOP)
  • ESOP
Employee Stock Option Plan (ESOP)
  • Author
    Rajat Khaneja
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In today’s scenario talent is the only thing by which any organization can grow efficiently and effectively at the same time. To promote talent among employees and to retain them, various organizations offer various schemes to their employees such as:

  • Employee stock option plan
  • Employee stock purchase schemes
  • Stock appreciation rights schemes
  • General employee benefit schemes
  • Retirement benefit schemes

Among all, many companies resort to Employee Stock Option Plan (ESOP). It is a very important tool for the companies at a growing stage to attract and retain quality employees fostering in them long term attitudes. This option gives such employees, officers or directors (not being promoters) right to purchase or subscribe to the shares of a company at a future date at a predetermined price. It is a tremendous motivator and can make employees highly involved in their respective jobs and focused on corporate performance. For example, RBL Bank has allotted 2, 33,615 equity shares of the face value of Rs. 10 each under the ESOP Schemes of the Bank recently.

This scheme is defined under section 62(1) (b) of the Companies Act, 2013 and rule 12 of companies (share capital and debentures) Rules, 2014.

This option can be granted to directors (not being promoter), officers or employees of the following companies:

  • Company
  • It’s holding company
  • It’s subsidiary company

Eligibility of employees who can avail this option

 Employees to whom ESOPs can be given as per section 62 (1)(b) and rule 12 of Companies (Share Capital and Debentures) rules, 2014 includes the following:

  1. Permanent employees of the company who has been working in India or outside India
  2. A director of the company (not being a promoter), whether whole time or part-time but not an independent director.
  3. An employee as mentioned in a) and b) above of a subsidiary in India or outside India and of holding company of the company.

However, the above-mentioned employees doesn’t include the following:

  1. An employee who is a promoter or person belonging to promoter group.
  2. A director who either himself or through his relative or through any body corporate, directly or indirectly holds more than 10% of the outstanding equity shares of the company.
  3. A director who is also a promoter of the company.

Promoter means a person:

  1. Who has been named as such in a prospectus or is identified by the company in the annual return referred to in section 92; or
  2. Who has control over affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or
  3. In accordance with whose directions, advice or instructions the Board of Directors of the company is accustomed to act:

Provided that nothing in sub clause (c) shall apply to a person who is merely acting in a professional capacity

Objectives of issuing ESOP

  • ESOPs are used as a tool for attracting and retaining high-quality employees.
  • Making ESOP a part of offerings to employees is the best way to get the team working better and longer.
  • ESOPs bring the sense of pride to employees being the part of business growth and stability

Important Definitions related to ESOP

  • Employee stock option: As per section 2(37) of Companies Act, 2013 ESOP means, the option given to the directors, officers or employees of the company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.
  • Grant date: The date on which the option is granted by the company to the employee. Grant is a formal action taken by the company and the employee is informed of the entitlement by way of a grant Letter.
  • Vesting Period: The minimum period that the employee has to serve to be entitled to the stock option. The average vesting period ranges between 3 – 5 years. Most companies tranche out the total entitlement.
  • Exercising Period: The period post vesting, during which the employee can exercise the option to buy the shares. ESOPs can also be structured to address the eventuality of the employee leaving the company during the exercise period.
  • Exercising Date: The date on which the employee exercises the option to buy the shares.
  • Exercising Price: It’s a pre-determined price at which the employee will buy the shares.

Procedure for ESOP

  1. The procedure for ESOPs in a private company starts with drafting the scheme of ESOP
  2. Convene Board meeting to approve the scheme of ESOP by passing a board resolution.
  3. Call general meeting to get the approval of shareholders for the proposed scheme, as approved by the Board, by passing a special resolution. In case of a private limited company, only ordinary resolution can be passed.
  4. However under ESOP, if shares to be issued is equal to or more than 1 % of issued capital of the company, a separate resolution is required to be passed by the shareholders.
  5. The company shall within 30 days of passing special resolutions, file form MGT-14 with ROC to intimate ROC of approval of the scheme. In case of a private limited company, since ordinary resolutions is passed, there is no need to file MGT-14 with the ROC.
  6. After approval by shareholders of such scheme, the option shall be granted to the employees.

Terms for ESOP

  1. Pricing: Companies granting option to its employees pursuant to ESOP will have the freedom to determine the exercise price in conformity with the applicable accounting policies.
  2. Variation in term of ESOPs: A company may vary the terms of ESOP not yet exercised by the employees provided such variation is not prejudicial to the interest of option holders.
  3. Minimum period during which option is available: There shall be a minimum 1 year period between grant of option and exercise of the option.
  4. Lock-in period: The Company shall have the freedom to specify the lock-in period. Lock-in period is a period during which the shares cannot be traded.
  5. Right to receive dividend: the employees shall not have right to vote or dividend in such option till shares are issued on exercise of option.
  6. Option not transferable: The option granted to employees shall not be transferred to any person and neither it shall be pledged, encumbered, hypothecated or mortgaged.
  7. Who can exercise the option: only employees to whom option has been granted can exercise the option.
  8. Register of ESOP: The Company shall maintain register of ESOP in form SH-6 containing therein the particulars regarding ESOPs.
  9. Disclosure in Director’s Report: Following details shall be included by Board of Directors in Director’s Report:
  • Options granted
  • Options vested
  • Options exercised
  • Total number of shares arising as a result of the operation
  • Options lapsed
  • Exercise price
  • Variations of terms of the option
  • Employee wise details of option granted
  • As and when options are exercised, the company shall file the return of allotment in form PAS-3 to ROC to intimate that shares have been issued to employees in respect of which of the option.

Taxation in case of ESOP

Employee Stock Option Plan is considered as perquisites with respect to taxation. On the other hand, for an employee, ESOPs are taxed at two below mentioned instances:

While exercising the option – in the form of a prerequisite. When an employee exercises her/his option, the difference between Fair Market Value (FMV) as on the date of exercise and the exercise price is taxed as a perquisite.

The employer is liable to deduct TDS on such amount. Such amount will be reflected in Form 16 and Form 12BA of the employee.

While selling the shares – in the form of capital gain. An employee might sell his shares after buying them. In case he sells these shares at a price higher than FMV as on the date of exercise, he would be liable for capital gains tax.

For eg., Sale price= Rs. 230 and Fair Market Value = Rs. 150.

Scenario 1: If he sells these shares within or less than one year of exercising the option (Taxable amount= Sale price on the date of sale – FMV on the exercise date)   Scenario 2: If he sells these shares more than one year of exercising the option (Taxable amount= Sale price on the date of sale – Indexed FMV on the exercise date)
Tax rate as per slab rate*(230-150)
(Short term Capital gains)  
Case 1: With Indexation benefit 20%*(230- 150*CII of the sale period/CII of exercise period)
Case 2: Without Indexation benefit 10%*(230-150) (Long term Capital Gains)

Note: The capital gains would be taxed depending on the period of holding. This period is calculated from the date of exercise up to the date of sale.

For listed companies, SEBI ESOP GUIDELINES are required to be followed for issuing ESOPs. The same shall be shared separately in the upcoming blogs.


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