In an ESOP, the employee gets the right to acquire ownership in the shares of the company on the bases of its effectiveness and years of service. It basically means the employee has the option to purchase stock of the company at a future date at a pre-determined price. The pre-defined price is called strike price or grant price.
The shares are generally provided at a lesser rate than the market value to the employees. There is a vested period, of which the buying needs to be exercised, post that the option would lapse and the employee won’t have any rights to the share. It is a basic practice that the organization implements to remunerate and retain employees.
The benefit that an individual can take of an ESOP is when the market price of the stock is higher than the acquired price, the individual can exercise the option at profit immediately. However, if the price is lower to its expectation the individual sets aside exercising the option. For example, let say you are offered 3000 ESOPs by your employer, vesting period is 3 years and the price is 150 per share. During the end of 3rd year, the market price happens to rise up to 200. The employee can utilize the opportunity of exercising the option and selling at profits. While he would avoid doing so, if the market price reaches 130.
The purpose of an ESOP is mainly – to boost employee morale and motivate them towards the performance of the organization, through equity ownership of the company. The basic purpose is to retain the employee in the company and expect good performance in the organization. An opportunity for employees to avail wealth benefit by selling the shares on profits that are acquired at a lower price.
Exercising the option – it means to purchase the stocks given in option. As employee has a stimulated time frame, i.e. vesting period to exercise the option, until then the employee has the choice to exercise the option or not. For the stocks that are not listed on the exchange, the investor can sell the stock or liquidate his money only when the stock gets listed on the exchange or if the promoter offers an exit deal. For the stocks that are listed on the exchange, the investors exercise the option issued as per SEBI regulations.
Taxability on ESOPs – ESOPs are taxed on 2 transactions, buy and sell of the options. When the option is exercised, the difference in market value and grant value is treated as perquisite as per Income Tax Act, 1961. When the shares are sold against the market value, the profits earned could be treated as capital gains.
The Fair market value of listed shares is calculated taking average of opening and closing prices as of the date of exercising the option. This, fair market value calculation varies from company to company. And for unlisted shares other than equity shares the value would be based on the exercising or an earlier date determined by merchant banker, the earlier date could not be more than 180 days of exercising the option. The taxable value of perquisites is the fair market value of shares on the date of exercising the option, less the amount recovered from the employee on such shares.
For start-ups, the taxable value of perquisites as per the finance act, 2020 is within 14 days of the events below the tax has to reach the government. The events are from the date of allotment to the earliest the expiry of 48 months from the end of the assessment year, the date at which employee ceases to be start-ups employee and on the sale of such shares by the employee. Thus, as stated by the income tax, 17(2)(vi) has not been amended, thus the tax could be paid in the subsequent years as the income shall be computed in the year of shares been allotted.
An ESOP funding enables you to purchase the shares which you are entitled, by acquiring valuable capital that is funded to you as a loan. This, finances both the exercise price and perquisite tax that you are liable to pay. It is mainly like a fund offered to avail an aggregate loan amount up to a defined percentage of the current market price of the shares of the company. This funded loan could be repaid at any time until the tenure of the loan and the amount can be settled by using own source of funds or by selling the share.
ESOPs in a way are a good opportunity to grow wealth, when markets turn in your favour. Getting funding for ESOPs is much better as the focus could then be on other financial requirements. ESOPs funding in a way reduces the burden of accumulating the funds required to exercise the stock option.
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