An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers ownership interest in the company in the form of shares of stock. ESOPs give the sponsoring company—the selling shareholder—and participants various tax benefits, making them qualified plans, and are often used by employers as a corporate finance strategy to align the interests of their employees with those of their shareholders.
What is ESOP?
An ESOP (Employee stock ownership plan) refers to an employee benefit plan which offers employees an ownership interest in the organisation. Employee stock ownership plans are issued as direct stock, profit-sharing plans or bonuses, and the employer has the sole discretion in deciding who could avail of these options. However, employee stock ownership plans are just options that could be purchased at a specified price before the exercise date. There are defined rules and regulations laid out in the Companies Rules that employers need to follow for granting employee stock ownership plans to their employees.
How Does an Employee Stock Ownership Plan (ESOP) Work?
An ESOP is usually formed to facilitate succession planning in a closely held company by allowing employees the opportunity to buy shares of the corporate stock.ESOPs are set up as trust funds and can be funded by companies putting newly issued shares into them, putting cash in to buy existing company shares, or borrowing money through the entity to buy company shares. ESOPs are used by companies of all sizes, including a number of large publicly traded corporations.Contrary to what some people say, companies with an ESOP must not discriminate and are required to appoint a trustee to act as the plan fiduciary. Among other things, it is not possible for senior employees to receive more shares or for ESOP participants to have no voting rights.
Cost of ESOPs and Distributions
Legal fees, accounting fees, and administrative expenditures may be included in the initial costs of an Employee Stock Ownership Plan (ESOP) in India.
The cost of establishing and sustaining an ESOP varies according to the plan’s size and complexity.
Furthermore, ESOP distributions in India may occur in a variety of ways.
When an employee exercises their stock option to obtain shares, they have the option of selling them immediately or storing them for future appreciation.
If the employee decides to sell the shares, the proceeds, less any taxes due on the gain, will be sent to them. If the employee agrees to keep the shares, they will own a piece of the company and may be eligible for dividends or capital gains if the stock price rises.
Why Company offers ESOPs to their employees?
Organisations often use Employee stock ownership plans as a tool for attracting and retaining high-quality employees. Organisations usually distribute the stocks in a phased manner. For instance, a company might grant its employees the stocks at the close of the financial year, thereby offering its employees an incentive for remaining with the organization for receiving that grant. Companies offering ESOPs have long-term objectives.
Not only do companies wish to retain employees for the long term, but also intend to make them the stakeholders of their company. Most of the IT companies have alarming attrition rates, and ESOPs could help them bring down such heavy attrition Start-ups offer stocks for attracting talent. Often such organisations are cash-strapped and are unable to offer handsome salaries. But by offering a stake in their organisation, they make their compensation package competitive.
ESOPs from an employee’s perspective
With ESOPs, an employee gets the benefit of acquiring the shares of the company at the nominal rate, and selling them (after a defined tenure set by his employer) and making a profit. There are several success stories of an employee raking in riches together with founders of the companies. A very notable example is Google when it went public. Its founders Sergey Brin and Larry Page became the richest persons in the world, even the stock-holder employees earned millions too.
ESOP Taxation
ESOPs have dual tax effects:
- When an employee exercises their rights and purchases company stock
- When the employee sells the stock after purchasing it
Let’s take a closer look at these examples:
Tax treatment at the time of buying the shares
Employees can purchase shares after the vesting date at a price less than the share’s Fair Market Value (FMV) on that date. As a result, the difference between the FMV and the exercise price of the share is considered a pre-condition in the employee’s hands and taxed at his income tax slab rate.
However, in the case of new businesses, the government has softened the tax implications of ESOPs.
Employees at the start-up would not have to pay the tax on the perk in the year in which they exercised the ESOP. TDS on ESOPs would be delayed until the sooner of the following dates:
- Five years from the date of the ESOP grant
- When does the employee sell the ESOP?
- Date of departure from the company
Tax treatment at the time of selling the shares
If the employee sells the shares, the difference between the selling price and the FMV on the date the share was exercised is taxable as capital gains.
If you sell your shares within a year of buying them, you will have to pay a 10% tax on any profits over Rs.1 lakh. If the shares are sold within 12 months, the profits are taxed at 15%.
Taxation of foreign ESOPs in India is also similar, and you would be taxed in India on the perquisites earned from a foreign company.
Benefits of ESOPs for the employers
Stock options are provided by an organization as a motivation to its employees. As the employees would benefit when the company’s share prices soar, it would be an incentive for the employee to put in his 100%. Although motivation, employee retention and awarding hard work are the key benefits which ESOP brings to employers, there are several other noteworthy advantages too. With the help of ESOP options, organisations could avoid cash compensations as a reward, thus saving on immediate cash outflow. For organisations which are starting their business operations on a bigger scale or expanding their business, awarding their employees with ESOPs would work out to be the most feasible option than the cash rewards.
ESOP and Other Forms of Employee Ownership
Stock ownership plans provide packages that act as additional employee benefits and embody the corporate culture that company managements want to maintain. Other versions of employee ownership include direct-purchase programs, stock options, restricted stock, phantom stock, and stock appreciation rights.
- Direct stock purchase plan (DSPP)- lets employees purchase shares of their respective companies with their personal after-tax money. Some countries provide special tax-qualified plans that let employees purchase company stock at discounted prices.
- Restricted stock- gives employees the right to receive shares as a gift or a purchased item after meeting particular restrictions, such as working for a specific period or hitting specific performance targets.
- Stock options- provide employees the opportunity to buy shares at a fixed price for a set period.
- Phantom stock- provides cash bonuses for good employee performance. These bonuses equate to the value of a particular number of shares.
- Stock appreciation rights- give employees the right to raise the value of an assigned number of shares. Companies usually pay these shares in cash.
FAQs
What Does ESOP Stand for?
ESOP stands for employee stock ownership plan. An ESOP grants company stock to employees, often based on the duration of their employment. Typically, it is part of a compensation package, where shares will vest over a period of time. ESOPs are designed so that employees’ motivations and interests are aligned with those of the company’s shareholders. From a management perspective, ESOPs have certain tax advantages, along with incentivizing employees to focus on company performance.
How Does an ESOP Work?
First, an ESOP is set up as a trust fund. Here, companies may place newly issued shares, borrow money to buy company shares, or fund the trust with cash to purchase company shares. Meanwhile, employees can accumulate a growing number of shares, an amount that can rise over time depending on their employment term. These shares are meant to be sold only at or after the time of retirement or termination, and the employee is remunerated by receiving the cash value of their shares.
Are ESOPs Good for Employees?
Yes, ESOPs can generally be considered a benefit for workers. These programs tend to be adopted by companies that don’t chop and change staff frequently and often result in a bigger payout and greater financial compensation for employees.
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tnreginet |rajssp | jharsewa | picme | pmkisan | webland | bonafide certificate | rent agreement format | tax audit applicability | 7/12 online maharasthra | kerala psc registration | antyodaya saral portal | appointment letter format | 115bac | section 41 of income tax act | GST Search Taxpayer | 194h | section 185 of companies act 2013 | caro 2020 | Challan 280 | itr intimation password | internal audit applicability | preliminiary expenses | mAadhar | e shram card | 194r | ec tamilnadu | 194a of income tax act | 80ddb | aaple sarkar portal | epf activation | scrap business | brsr | section 135 of companies act 2013 | depreciation on computer | section 186 of companies act 2013 | 80ttb | section 115bab | section 115ba | section 148 of income tax act | 80dd | 44ae of Income tax act | west bengal land registration | 194o of income tax act | 270a of income tax act | 80ccc | traces portal | 92e of income tax act | 142(1) of Income Tax Act | 80c of Income Tax Act | Directorate general of GST Intelligence | form 16 | section 164 of companies act | section 194a | section 138 of companies act 2013 | section 133 of companies act 2013