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Latest reports suggest about significant growth rate of Indian start-ups. It demands strategic utilization of the resources to empower the team. In an extremely competitive scenario, it is essential to offer lucrative deals for retention of key employees. In this context, ESOP or Employee Stock Options can be an incredible option for start-ups.

Understanding ESOPs and its benefits

So, what is ESOP? Through ESOPs, the employees become eligible to buy shares of the concerned company at a much lesser price. It thus can act as a significant retirement plan for the benefits, making the concerned start-up more trustworthy. On most occasions, ESOPs ultimately become an integral part of compensation, encouraging employees to work harder for the organization. However, ESOPs are provided optionally for the staff or its associated companies. But the benefit is that it gives the right to the key employees, managerial level professionals, and staff to buy shares at a previously fixed rate. It makes employees an integral part of the success of a company. This enables them to gain financial benefits upon selling lucrative shares being purchased at a nominal price.

On numerous occasions, the foreign subsidiary company allows such options for the employees of Indian subsidiary organization. The stock options are especially beneficial for start-ups who can’t offer massive salaries to their employees but are interested in making them a part of their future success.

Giving a sense of ownership

As per the ESOP scheme, the norms as per which employees can access their rights are known as the ESOP scheme. An employee can exercise the rights post a specific duration, which is often more than one year. The right to exercise the option might get conferred with the employee in future days. The concerned date on which the concerned start-up employees do get authorization of having rights of acquiring share is generally called the ‘vesting date’ as per official term. The rights might be vested completely or partly over the assigned vesting period. For example, if an employee is offered x number of options on a certain date that can be exercised in terms, like around 20 percent post ending of first year, thirty percent post completing the second year and the rest upon completion of the third year from the date of acknowledgment.

The plan may specify similar or varying grant prices or have access to price for the vesting of such. In general, the grant price or the concerned price on which an employee can manage to purchase the company's share often remains constant. It is often considerably lower than the existing market price of the share if the share remains enlisted.

As the employee is simply given a choice without involving any compulsion, they (employees) can feel flexible to exercise the choices. It’s up to them whether they would wish to work upon the same or let it get lapsed if the concerned share price is lesser in comparison with the price that is exercised. Here the employees are assigned with a period within which they must exercise the available choices. Upon failing to exercise the same, the rights may get wasted. Concerned date when the employees do exercise the available choices for purchasing the shares is called the ‘exercise date.’ There remains no cash outflow or implications concerned with taxation when the choices are given the grant and when the choices are conferred upon the employee.

Best time for exercising the choices

No employee needs to exercise the choices after it vests with him/her. The concerned employee can have his rights exercised within the given period. Timing of exercising the available options by the employee is a crucial aspect from finance and taxation perspective. After the employee has his options exercised, he can make payment for the shares at a cost decided earlier and thus making cash outflow. If the shares don’t get enlisted upon stock exchange, it simply can’t be liquidated, and hence money gets trapped until the shares get enlisted, or the promoters come up with the option of exiting. Additionally, there remain implications of taxation upon delaying the concerned date as the duration of holding for gaining the capital will initiate from the date of exercise. Ultimately, the decision is essential to be taken post considering the cash flow and the tax implications associated with the decisions like these

Taxation when it comes about actually exercising the choices

ESOP taxation often comes up with a regular pattern. In general, taxation of it is accomplished on a couple of levels. The initial level is when the employee exercises the choices of purchasing the shares at the exercise cost. The next level is the one when these are finally sold.

To start with the initial level, whenever the choices within the ESOPs are accessed, the distinction between the cost of exercising and security is considered a prior requirement that remains an option for the employee. The employer needs to reduce tax at the source over employee exercise, dealing with the same as a prior requirement. The worth of the share assigned for the employee will be the average of the market value, i.e., the average between the maximum and minimum cost, at the concerned date on which option is exercised when the shares get listed over the Indian stock exchanges. If the shares don’t get enlisted, the most justified market worth of it will be according to valuation certificate obtained through the merchant banker. The certificate meant for share valuation is essential not to be more than 180 days old from the concerned date of exercising the same. Even if the shares do get enlisted exterior to India, the company must get the certificate through the Merchant Banker as the shares like these are considered the unlisted ones meant for ESOP.

Taxes applied when the shares obtained under ESOP are laid off

Taking a peek into the other side of the ESOP shares' taxation, it is about when the employee goes for selling the shares. The occurrence of share is obvious to make capital gains taxes look significant. It can be either long term gain or short term, by the duration for which the employee holds the share. The period of holding often differs for the shares listed and also for the shares not listed. Listed shares turn long term upon being held for more than one year. Shares that are unlisted turn long term generally after three years. In the ongoing budget, the duration of three years has been proposed to get lowered to a couple of years.

Short and long term taxation rate

The rate of taxation for the short and long term depends on whether the shares are traded over the stock exchange platform over which the payment for Security Transaction Tax is made. If the trading of shares is done through brokers, the taxation of long-term capital gains is done as per Section 112A at a 10% rate for an amount beyond Rs 1 lakh of capital gains. But the short-term capital gains of such are taxed at a fixed rate of 15% as per the Section 111A.

But when the selling of shares is not done through the stock exchange, the calculation of long term capitals are done post using the indexation with the initial price of purchasing. Thus, indexed gains are taxed at a straight rate of 20 percent along with various associated sub charges and education amounts. Ultimately, there remains the option of paying tax at 10 percent on capital gains without going for indexation advantages. The short-term capital gains can be dealt with as of any other earning and included with other earning, and the taxation of which is done at the applied slab rate.

To compute the capital gains, the fair market worth as of the date of exercise is considered to have the pre-requirement of the option, which is considered the value of acquisition and not the value paid by the concerned employee. The tax implications have to vary if the ESOPs are assigned to someone who is not a staff either by the holding company or the subsidiary company or any director at non-executive level or anyone else who is eligible.

Taxation aspects about the Foreign ESOPs

If the ESOPs are allowed by foreign ventures to an Indian, the same can be taxed in India. Most importantly, the discounting tax applied upon long term capital gains as per Section 112 A or the discounting rate of 15 percent tax upon short term capital gain by the shares of such won’t be there, keeping in mind that the shares won’t be sold at the Indian stock exchanges, because these hold less possibility of being listed in India.


All said and done, turning ESOP into a package for the employees is the most effective way to encourage them and make them associated with the company. It gives them a feel of authorization and makes them feel responsible for the concerned business and work for its success.

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