Esops- Financial

8/12/2019 Esops- Financial

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DIFFERENT TERMS USED IN AN ESOP

Employee Stock Option Plan (ESOP), is a plan through which a company awards Stock

Options to the employees based on their performance. Under an ESOP, the employees have

right to buy the shares of the company on a predetermined date at a predetermined price. The

objective of ESOP is to motivate the employees to perform better and improve shareholders'

value. Apart from giving financial gains to the employees, ESOP also creates a sense of

belonging and ownership amongst the employees. A stock option granted to specified

employees of a company:

Grant date:

The date on which the company grants an option to its employee.

Option price:

The price at which such shares in a scheme are offered. It is also known as the strike price

or grant price. Normally such option price would be below the market value/ fair value of

the shares on the date of grant.

Vesting period:

Vesting has two components vesting percentage and vesting period. Vesting percentage

refers to that portion of total options granted, which you will be eligible to exercise. Vesting

period is the period on the completion of which the said portion can be exercised.

For Example: Mr Deepak has been given a stock option from his company for a vesting

period of 3 years in the year 2 February 2012. This means that vesting date is 2 February2015. The price at which 500 shares were offered to Mr Deepak was Rs 250 each. This price

is the vesting price. This means that on 2 February, 2015 he can exercise his right to purchase

the share, depending on the conditions.

Lets say, the price of share on 2nd Feb, 2015 is 650, this will result in a gain of Rs 400 each,

which garners a profit of Rs 2,00,000 to the employee, if he exercises the option after 3 years.


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Exercise period and Exercise date:

The employees would be given a time period, called exercise period, within which they are

required to exercise the option. The date on which employees exercise this option is called

exercise

Exercise period is the period within which you can decide to exercise your options. This

period starts from the date of vesting.

Lapse of options

Options lose their validity in certain circumstances i.e. expiry of the exercise period,

separation, abandonment etc. These options then cannot be converted into shares and lose

their value. Such options are said to be lapsed.

SEBI GUIDELINES

1. Issue at discount

Issue of stock options at a discount to the market price would be regarded as another

form of employee compensation and would be treated as such in the financial

statements of the company regardless the quantum of discount on the exercise price of

the options.

2. Approval:

The issue of ESOPs is subject to the approval by the shareholders through a specialresolution.

3. Minimum period and Maximum period

A minimum period of one year between grant of options and its vesting has been

subscribed.. A Maximum period of eight year between grant of options and its

vesting has been subscribed. Employee stock option must be exercised within the

period of five years


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4. Superintendence

The operation of the ESOP Scheme would have to be under the superintendence

and direction of a Compensation Committee of the Board of Directors in which

there would be a majority of independent directors.

5. Eligibility

ESOP scheme is open to all permanent employees and to the directors of the company

but not promoters and shareholders. The scheme would be applicable to the employees

of the subsidiary or a holding company with the express approval of the shareholders.

6. Director's report

The Director's report shall make a disclosure of the following:

Total number of shares as approved by the shareholders

The pricing formula adopted

Details as to options granted, options vested, options exercised and options forfeited,

extinguishments or modification of options, money realized by exercise of options,

total number of options in force, employee-wise details of options granted to senior

managerial personnel and to any other employee who receive a grant in any one year

of options amounting to 5 percent or more of options granted during that year

Fully, diluted EPS computed in accordance with the AS-20


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RULES AND REGULATIONS

Companies Act

Issue of stock options requires approval of shareholders by way of a special resolution as per

section 81(1 a). This is not applicable for private companies who can issue stock options

without shareholder approval but approval by the board of directors.

Income Tax Issues

For employees:

Till recently, the difference between the cost of the share to the employees and market value

on the date on which an employee got the share would be taxed as perquisite in addition to

capital gains tax payable by the employee on sale of those shares. However with the recent

announcement by the Finance Minister the perquisite tax has been removed. Tax is now

payable only at time of sale of shares as capital gains.Since perquisite tax has been removed

employers are not liable for tax deduction at source, thus removing administrative

inconvenience.

For the company:

As per SEBI guidelines listed companies have to account for ESOP by treating the same as an

expense. As yet there is no clarity whether this expense will be allowed as deductible expense

by the Income Tax authorities.


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Taxation Of ESOPsIn India

Until 1995, there was no provision to tax ESOP. But, in that year, Income Tax Authorities

clarified with the help of a circular that these options which make the shares of company

available to employees at lower than market price will attract taxes. First and foremost thing

is the discretion of the employee. Exercising of option or its rejection is totally dependent on

the employee. ESOP benefits form a part of employee salary and are taxable as a perquisite.

The calculation is based on the Market Value of share at the date of exercising of option and

the vested price. Ordinary residents are liable to pay these taxes on the basis of global

income.

For Companies Listed In India:

For all the companies listed in India, 15 percent of the tax is charged under Short Term

Capital Gains. Long Term Capital Gain Tax (LTCG) doesnt arise in this case.

For Companies Listed Outside India:

For the companies those are not listed in India but listed in other exchanges across the globe,

the Short Term Capital Gain will be added as a part of salary and tax is charged based on the

salary slabs. LTCG charged is 20 percent along with indexation.

Example: Employer has given the option of allotment of total 400 shares, for the next 4

years, for all eligible employees. The vesting price is Rs 100 and starting date of allotment is

1 July 2010. Mr Raj, one of the company employees is allotted 100 shares on 1 July 2010, at

the vesting date the price of share is Rs 500. He sells these shares at Rs 1500 on 1 December

2011.

TAX At the time of Allotment: STCG will be (500-100) * 100 * 20% = Rs 8000

(Considering Mr Raj is in 20 percent bracket).

TAX At the time of Sale: (1500-500)*100*15% = Rs 15000

There have been various changes in the taxation of ESOPs in the past 20 years. The

Government finally seems to have found a logical way of taxing ESOPs. The manner of

computation of Tax of ESOPs in the hands of the employee has been explained hereunder:-


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At the time of giving ESOPs:

The benefits arising on ESOPs are taxed as Perquisites in the hands of the employee and

form a part of the employees salary income. The employer is also required to deduct TDS in

respect of such perquisite. The perquisite value is computed as the difference between the fair

market value of the share and the Exercise price.

At the time of sale of such ESOPsby the employee:

The gains arising on the sale of ESOPs are considered to be Capital Gains; Capital Gains

Tax is levied on the such gains and tax is liable to be paid in the year in which such ESOPs

are sold. The Capital Gain is computed as the difference between the sale price and the price

at which it was awarded by the Employer.

The Capital Gains treatment further depends on the holding period of the ESOPs i.e. if the

shares are held for less than 12 monthsShort Term Capital Gains Tax@ 15% is levied and

if the shares are held for more than 12 months- Long Term Capital Gains Tax is levied (this

is currently NIL). Thus, if such ESOPs are held by the employee for more than 12 months,

the gains arising on the sale of such ESOPs is effectively exempt from Tax.

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Esops- Financial