Section 2(37) of the Companies Act, 2013 defines “employees’ stock option” to mean the option given to the directors, officers or employees of a company which enables such directors, officers or employee, the benefit or right to purchase or subscribe to the shares of the company at a pre-determined price.
Employee Stock Option Plans are one of the most important tools to attract, encourage and retain employees. It is the mechanism by which employees are compensated with increasing equity interests over time.
Under Section 62 (1) (b) of the Companies Act 2013, where at any time a company having a share capital proposes to increase its subscribed capital by the issue of further shares, such shares may be offered to employees under a scheme of employees’ stock option, subject to a special resolution passed by the company and subject to such conditions as may be prescribed.
Some Important terms under ESOP are as follows:
Grant Date:
The grant date in when company officially offers the ESOP to employees. The company takes a formal action known as granting and the employees are informed regarding their respective entitlement through a grant letter.
Exercise Price:
The pre-determined price at which the employee will buy the shares.
Exercise Date:
The date on which the employee exercises the option to buy the shares.
Vesting Period:
The minimum period that the employee has to serve to be entitled to the stock option.
Exercise 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 exercise period.
Benefits of issuing ESOP:
Company:
By offering ESOPs, Company can retain talented employees, boost productivity and attract new employees, especially in the initial stages when high salaries may not be feasible.
Employees:
ESOPs offer several benefits to employees such as stock ownership, dividend income and the ability to buy shares at a discounted rate. Employees can become part owners of the company, earn additional income through dividends, and invest in the company at a preferential rate.
Participate in ESOP:
Eligibility for ESOPs is extended to employees, with the exception of directors who hold more than 10% equity in the company, promoters, or individuals who are part of the promoter group (including immediate relatives).
Taxation Policy:
5.1 The issue of ESOPs and Tax implications:-
5.1-1 If ESOPs issued in any previous year but up to previous year 2008-09
| Under the head Salaries | Since ESOPs are perquisites, not taxable under this head. | |
| Under the head Capital Gains | Sale consideration | Regular |
| Cost of acquisition | If shares are allotted before 1-4-2007- at Actual cost | |
| If shares are allotted on or after 1-4-2007 but before 1- | ||
As said, ESOP will be taxed in two stages. In first, when an employee exercises his option at the exercise price and thereafter, when the shares are sold. In the first stage, the difference between the exercise price and the value of the shares is treated as ‘Perquisite’ in the hands of the employee and the employer is required to deduct tax at source.
The value of the shares allotted to the employee shall be the average of market price, i.e., average of highest and lowest price, on the date when the option is exercised in case the shares are listed. In case of the unlisted shares, the FMV as per the Valuation Certificate obtained from the merchant banker. The said certificate should not be older than 180 days from the date of exercise of his option. Again, when the shares are disposed off they will attract Capital Gains Tax. Same can be either long-term or short-term, depending on the holding period. However, the holding period is different for listed and unlisted shares. Listed shares shall become long-term if held for more than one year. Unlisted shares become long-term after three years. Further, by the Finance Act, 2018 the period of three years has been reduced to two years. In case shares are traded, the long-term capital gains will be taxed under section 112A at 10 per cent over Rs. 1 lakh of capital gain. Similarly, if it is short-term capital gains, then the same will be taxed at a flat rate of 15% under Section 111A of the Act. In case of unlisted shares, the long-term capital gains shall be calculated after applying the indexation and any gains will be taxed at a flat rate of 20% plus applicable surcharge and education cess. An employee has an option to pay tax at 10% on capital gains without applying for indexation benefits.
Procedure for Issue of Employees Stock Option:
| Description of Activity | Timeline |
|---|---|
|
1. To make application for availing DMAT facility if the Company aspires to issue in DMAT form |
T |
|
2. Drafting the ESOP scheme and issue notice of Board meeting |
T |
|
3. Convening of Board meeting for
- Discussing the proposal for increase in authorised capital - Approval of ESOP scheme - Issue of Notice of General Meeting - Approval of Valuation report - Amendment of AOA |
T+7 |
|
4. Issue Notice of General Meeting |
T+7 |
|
5. Approving the business of - Increase in authorised capital - Proposal of ESOP - Amendment of AOA |
T+28 |
|
6. The approval from shareholders shall be obtained by the company by passing a separate resolution if, a) Grant of options to employees of subsidiary or holding company or b) grant of an option to identified employees, during any one year, equal to or exceeding 1 percent of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of an option. |
T+28 |
|
7. Filing Form MGT-14 within 30 days of passing the resolution |
T+58 |
|
8. Granting options to the eligible employees, following approval of the ESOP scheme by the shareholders. |
T+58 |
|
9. Vesting of Options. There should a minimum gap of 1 year between the grant of options and vesting of options. |
T+28+365 |
|
10. Employees exercising options. |
E |
|
11. Allotment of Shares. File for PAS-3 with the Registrar of Companies (RoC) when the options are exercised by the employees. |
E+30 |