The significance of Employee Stock Ownership Plans (ESOPs) as an employee encouragement and reward mechanism is growing given its numerous benefits. An increasing number of companies are tapping on the tool to ensure that employees are rewarded for their loyalty and for working with a sense of ownership in the company.
How do ESOPs Function?
ESOP is a type of employee benefit plan or an incentive tool that gives the right to employees to purchase a certain number of the company’s shares at a predetermined price after the expiration of a predetermined period (popularly known as the vesting period). ESOPs as a part of compensation strategy, not only help in creating wealth for employees but also, ensure that employees’ objectives are aligned with the company’s vision.
Following are the key features of ESOPs:
Before we dig deep, let us first understand some major terms related to ESOPs
Once stock options are granted, there is a vesting period which is usually 1 year. The right to convert the stock options into equity i.e. vesting activates once the vesting period has lapsed. Thereafter, subject to the ESOP scheme issued by the employer, the employee has a right to exercise his vested options by paying an exercise price
Once the stocks are vested, an employee can choose to:
ESOPs Benefits for Employees
ESOPs benefit employees in the following ways:
Wondering what companies see while granting ESOPs? There are various parameters such as loyalty, designation, performance, present & potential contribution and opportunity cost.
Who is Entitled to ESOPs?
Let us understand what kind of employees are actually entitled to ESOPs. This includes employees of the company, its holding & subsidiaries and foreign employees. ESOPs may be issued to:
Following are the ones who are not covered:
Who Can Exercise the Options?
No person other than the employee to whom ESOPs are granted can exercise the option. However, in case of the death of the employee, while he is in employment, all the granted options get transferred to the nominees. Further, if the employee faces a permanent incapacity during his employment, all the granted options shall vest in him on that day. In case of termination or resignation, the employee can exercise the options granted to him. However, options not vested in the employee on that day shall expire.
Tax Involvement
There are two levels of taxation in the case of ESOPs. The first stage is when the ESOP option is exercised – the employer is required to deduct tax from the employee on the difference between the exercise price and the market value of the security which is considered a perquisite in the employee’s hand. The second stage is when the shares are eventually sold as the difference between the selling price and the fair market value of the shares on the day they were exercised is liable to capital gains tax upon its sale.
ESOPs: A Great Option to Opt For
ESOPs are beneficial to both employees and employers. While companies leverage ESOPs as a growth multiplier, employees benefit immensely from the reward and monetary benefits. It boosts their personal wealth, helps them grow professionally, improves job security and satisfaction and makes them more responsible for their job. Employees must however keep themselves abreast on the performance of their shares at the stock market to be able to realize its full potential.
Note: The above interpretation is based on our view. Taxation rules & regulations will be applicable as per local land laws.
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