[2022] 138 taxmann.com 276 (Article)
Background
Companies often resort to introducing employee rewards through Employee Stock Option Scheme for company’s long-term growth and shareholder value creation and also to attract, retain and motivate the best available talent. In other words, it is a mechanism by which employees are compensated with increasing equity interests over time. Employee Stock Option Plan (ESOP) is an option to its employees to acquire Equity Shares of the company at a future date and at a pre-determined price. There is no limit on the quantum of ESOPs to be issued to employees.
Various modes of ESOP Plan
The various modes through which a ESOP plan can be implemented is through (a)ESOP (b) Employee Stock Purchase Plan (ESPP) (c) Stock Appreciation Rights-cash (SAR) (d)Stock Appreciation Rights -Equity (e) Restricted Stock Unit (RSU).
ESOP: It is a right offered by a company to its employees to take equity shares of a company at discounted price.
ESPP: It allows Employees to purchase the company’s shares, often at a discount from Fair Market Value.
RSU: Employee is awarded with the shares subject to fulfilment of certain underlying conditions. The conditions may be for e.g. Target or revenue and performance based.
SAR: In this Scheme, the employee gets the benefit in the form of cash /equity which is the difference between the date of grant and final exercise of options.
Terms under ESOP
Grant: Offering and grant of ESOP Options from the corporate entity to Employees.
Vesting: Vesting is a process through which employee becomes eligible to exercise options.
Exercise: Exercise is nothing but when an employee applies to the Company for getting the shares allotted.
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FAQs
Section 2(37) of the Companies Act, 2013 defines employee stock option as: “The option given to the directors, employees or officers of the company or of its holding or subsidiary company, the right to subscribe for the shares of the company at a predetermined price on a future date.”
What are the four 4 benefits of implementing an ESOP in an organization? ›
Stock contributions are also tax-deductible since they are used to repay the ESOP loans. ESOPs create an ownership culture that is also good for company morale, productivity, recruitment and retention. Company performance has a direct, tangible effect on employee benefits.
What is the ESOP 25% rule? ›
Each eligible ESOP participant (“Eligible Participant”) must be provided the opportunity to diversify up to 25% of his or her company stock account each year over a five year period, then increasing to 50% during the sixth and final year.
What is the latest amendment in ESOP? ›
Budget 2020 amendment – From the FY 2020-21, an employee receiving ESOPs from an eligible start-up need not pay tax in the year of exercising the option. The TDS on the 'perquisite' stands deferred to earlier of the following events: Expiry of five years from the year of allotment of ESOPs.
What is the procedure for ESOP as per companies Act 2013? ›
Procedure to Issue ESOP
A draft needs to be prepared of the ESOP according to the companies,2013 and Rules. A board meeting notice along with the draft resolution that is to be passed in the board meeting is to be made. The notice of the board meeting is to be sent seven days before the meeting to all the directors.
What type of legal entity is an ESOP? ›
An ESOP Is a Trust
The ESOP plan provides to each participating employee an individual account where benefits accrue over the years. The ESOP trust holds the shares of company stock and company contributions made to the ESOP. These contributions and shares of stock are credited to the individual participants' accounts.
What is the downside of ESOP for employees? ›
ESOPs are inflexible in some respects…
While ESOPs are flexible in many ways, they are subject to legal constraints. ESOP rules require that contributions be allocated based on relative compensation (ignoring compensation above a certain level) or some more level formula.
What are the disadvantages of an ESOP? ›
The Cons of an ESOP
Other detractors can include the following: Current shareholders are unlikely to maximize proceeds from a sale to an ESOP, as the ESOP is a financial buyer, not a strategic buyer. The ESOP can pay up to full fair market value but nothing more, whereas a strategic buyer may be able to pay more.
What is one major problem of employee stock ownership plans? ›
Equity and Debt of the Company
ESOPs can impact the cost of equity capital of a company as they often issue new stocks for ESOP, increasing the number of outstanding shares. As a result, it dilutes the existing shareholders' ownership stake and impacts the company's overall market capitalisation.
What is the 10 year rule for ESOP? ›
Diversification: ESOPs must permit participants who have reached age 55 and completed 10 years of participation in the ESOP the opportunity to begin diversifying their investment in company stock.
Cliff vesting describes a vesting schedule in which employees have no vesting until, after a minimum term of service (federal minimum requirement is 3 years, but ESOP company plans can vary), they become 100% vested.
What is the ESOP 30% rule? ›
IRC Section 1042 states that if after the sale of an ESOP (1) the ESOP owns at least 30% of the stock in the company, (2) the company is a C corporation, and (3) the selling shareholder has owned the stock for at least three years, there is a mechanism whereby the selling shareholder can potentially defer their capital ...
Are ESOPs federally regulated? ›
Like other qualified retirement plans, ESOPs are regulated under both the Employee Retirement Income Security Act (“ERISA”) and the Internal Revenue Code (“IRC”). Additionally, the rules relating to qualified plans under IRC Sec. 401(a) apply to ESOPs.
Can a company terminate an ESOP? ›
There are many mature ESOPs, and as time goes on various plans are terminating for a number of reasons, ranging from the sale of the company stock or assets, liquidation, high plan costs, and other factors.
Can a company keep your ESOP? ›
ESOP Up-Front Costs and Distributions
Companies often provide employees with such ownership with no up-front costs. The company may hold the provided shares in a trust for safety and growth until the employee retires or resigns.
What is the difference between an ESOP and an employee owned company? ›
Most employee ownership companies have a management and governance structure similar to other companies: a board of directors, elected by shareholders, oversees the company's activities and appoints the CEO. In ESOP companies, employees directly vote their shares in some cases, but these are rare.
What is Section 62 of the Companies Act 2013? ›
As per Section 62(1) of the Companies act, 2013 if the Company decides to issue fresh shares, these should be offered to existing shareholders in proportion to existing persons who are holders of equity shares. 'Right Issue' means offering shares to existing members in proportion to their existing share holding.
Is ESOP considered retirement? ›
Employee stock ownership plans (ESOPs) are a type of retirement plan that allows a company—most often a privately held company—to give shares of the business to its employees. Unlike many other types of retirement accounts, employees generally don't contribute to an ESOP. Instead, the company fully funds the benefit.
Are all employees eligible for ESOP? ›
ESOPs are much like other tax-qualified retirement plans. At least all employees who have worked at least 1,000 hours in a plan year must be included. They receive allocations of shares in the ESOP based on relative pay or a more level formula.
