Employee Stock option Plans (ESOPs)

Employee Stock Option Plans (ESOPs) are generally framed to reward employees for their performance, contribution to the Company. When an employee gets ESOPs from the company, it means he gets the right to purchase a certain number of shares in the company at a predetermined price after a predetermined period or periods. It also serves as a motivational tool as once you own the stock, you actually own a part in the company, and if the company does well the stock value rises. ESOPs also help in retaining employees. ESOPs are also called as Employee Stock Ownership Plans.

Types of ESOPs:

i) Employee Stock Option Scheme (ESOS):

Employee Stock Option Schemes are the most commonly used form for employee ownership. The option granted under the plan confers a right but not an obligation on the employee. Stock options are subject to vesting, requiring continued service over a specified period of time. Upon vesting of options, employees can exercise the options to get shares, by paying the pre-determined exercise price.

ii) Employee Stock Purchase Plan (ESPP):

Employee Stock Purchase Plans allow Employee to purchase Company’s shares, often at a discount from Fair Market Value. The terms of the Plan determine the tenure and price for possession of the Company’s shares by the Employees. Usually, ESPPs are being framed for offering shares as a part of public issues.

iii) Stock Appreciation Rights (SARs):

Although, SARs are not technically employee stock options, companies often use them in a like manner. SARs are profitable for employees when the company’s stock price rises. SARs provide employees with cash payments equal to the appreciation of the company’s stock over a specified duration. So unlike other plans, employees need not pay exercise price and it provides employees with equity upside without exposure to any downside.

iv) Restricted Stock Units (RSU):

Under Restricted Stock Units Plan, an Employee is awarded with the right to receive shares on a pre-determined date subject to occurrence of a specified event or fulfilment of specified conditions. In such kind of incentive plans, the Employee becomes shareholder only upon occurrence of a specified event or fulfilment of specified conditions.

Let us discuss ESOP/ESOS in detail below:

Definition:

Section 2(37) of the Companies Act, 2013 defines employees 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 purchase or benefit or subscribe for the shares of the company at a predetermined price on a future date.

Eligibility:

As per Rule 12(1) of Companies (Share Capital and Debentures) Rules, 2014, ESOPs can be issued to the following:

  • a permanent employee of the company who has been working in India or outside India; or
  • a director of the company, whether a whole-time director or not but excluding an independent director; or
  • an employee as defined in clauses (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company.

But, ESOPs shall not be issued to the following:

  1. an employee who is a promoter or a person belonging to the promoter group; or
  2. a director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten percent of the outstanding equity shares of the company.

However, in case of a Start-up, the conditions mentioned at (i) and (ii) above shall not apply for a period of 10 years from the date of its incorporation or registration.

1. Important Terms:

 1.1 Grant of option: Grant means the issue of stocks to the employees. It means informing the employee that he/she is eligible for and has been granted a specific number of ESOP. The company will have the freedom to determine the exercise price while providing the option of ESOP to the employees.

1.2 Vesting period: Vest means the right of the employees to apply for the shares granted to them. There shall be a minimum of one year between the grant of option and vesting of option for the ESOP scheme.

1.3 Exercise period: The exercise period is where the employees can exercise the option of buying the shares. The company will have the freedom to specify the lock-in period for the shares issued (if any) after the exercise of the option. The employees will not have the right to receive any dividend or to vote or enjoy the advantages of a shareholder in respect of the ESOP granted to him until the shares are issued on exercise of his option.

2. Procedure for issue:

Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of Companies (Share Capital and Debentures) Rules, 2014 (“Rules”) governs the issuance of ESOP for unlisted Companies. In case of listed companies, Securities and Exchange Board of India Employee Stock Option Scheme Guidelines shall be complied with.

2.1  Initial Documentation:

  • Get valuation report to ascertain the perquisite to the employee in terms of taxation and accounting.
  • Prepare the draft of ESOP in accordance with the Companies Act, 2013 and Rules made thereunder.

2.2  Meetings:

  1. Send the notice of the Board meeting to all the directors at least seven days before the meeting.
  2. Pass the resolution for:
  • the issuance of shares through ESOP, mentioning the total pool of shares that can be offered under the ESOP policy;
  • Separate resolutions shall be added, if options are proposed to be granted to:

-Employees of subsidiary or holding company; or

– Identified employees, during any one year, equal to exceeding one percent of the issued capital (excluding outstanding warrants and conversions).

– fixing time and date for calling the general meeting and approval of notice thereof.

3. Send notice of the general meeting to all the directors, auditors, shareholders and secretarial auditors of the company at least before twenty-one days of the date of the meeting.

4. Pass the special resolution (ordinary resolution for private companies) for the approval of ESOP and other resolutions as included in the Notice of the General Meeting.

5. File form MGT-14 with the Registrar of Companies within thirty days of passing the special resolution in the general meeting along with the documents.

6. Conduct a Board meeting for granting options to the eligible employees in terms of the ESOP policy. Also execute Options agreement if the employees accept the grant.

7. Maintain a ‘Register of Employee Stock Options’ in Form No.SH-6 and enter the particulars of the ESOP granted to the employees, directors or officers of the company.

8. Alteration of Articles of Association

If a private company wants to issue ESOP, then it should ensure that the Articles of Association (AoA) authorises for issuance of shares through ESOP. If the AoA does not authorise, then the company should pass one more special resolution to alter the AoA to include the provisions of issuance of shares through ESOP.

Important points to be considered:

(a) The option granted to employees is not transferable to any other person.

(b) The option granted to the employees shall not be pledged, hypothecated, mortgaged or otherwise encumbered or alienated in any other manner.

(c) Subject to clause (d) below, no person other than the employees to whom the option is granted shall be entitled to exercise the option.

(d) In the event of the death of employee while in employment, all the options granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.

(e) In case the employee suffers a permanent incapacity while in employment, all the options granted to him as on the date of permanent incapacitation, shall vest in him on that day.

(f) In the event of resignation or termination of employment, all options not vested in the employee as on that day shall expire. However, the employee can exercise the options granted to him which are vested within the period specified in this behalf, subject to the terms and conditions under the scheme granting such options as approved by the board of directors of the company.

3. Disclosures in Board Report :

The Board of Directors of the company, shall, inter alia, disclose in the Directors’ Report which is a part of the Annual Report for the year the following details such as:

  • the options granted, vested, exercised and lapsed,
  • the total number of shares arising as a result of exercise of options
  • the exercise price,
  • variation of terms of options,
  • money realized by exercise of options,
  • total number of options in force, and
  • employee wise details of options granted to the key managerial personnel, any other employees and identified employees.

 4.  Taxation Aspects:

Tax on ESOPs is levied at two stages-

4.1 First levy occurs at the time of exercise “as a perquisite”

The value of perquisite is arrived by calculating the difference between fair market value of the shares as on exercise date and the amount that employee has paid for exercising the shares. Perquisite is taxed accordingly under the head income from Salary and TDS is deducted by the employer.

Special provisions in case of starts-ups:

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 or;
  • Date of sale of the ESOPs by the employee or;
  • Date of termination of employment.

4.2 Second levy occurs when the employee opts to sell shares allotted “as a capital gain”

The difference between the sale price and FMV on the exercise date is taxed as capital gains. It might be either ‘Short Term Capital Gains’ or ‘Long Term Capital Gains’ depending upon the period of holding of such shares.

Disclaimer: The entire contents of this document have been developed based on relevant provisions and are purely the views of the authors. Though the author has made utmost efforts to provide authentic information, however, the authors and the company expressly disclaim all and any liability to any person who has read this document, or otherwise, in respect of anything, and consequences of anything done or omitted to be done by any such person in reliance upon the contents of this document.

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