What is ESOP? Is ESOP Good For Employees?

What is ESOP?

ESOP stands for Employee Stock option plan. Now a day, most of the start-ups in India uses this as a tool to maintain their employee turnover ratio. Being a Start-up, it is not easy for them to get experienced & talented personnel’s at lower packages, hence they also provide ESOP to its employees so as to make them owner in profits.

Under this Employee Stock option plan, the company provides its employees, an option to purchase its share, at concessional rates i.e. at the rates significantly less than the rates prevailing in the market on option date.

Hence, the employees of the company will also be able to purchase the shares of a company at less than the market rates, which makes it a lucrative instrument for employees also.

Since employees are getting the companies share at lower prices, the price less paid by employee in comparison to the market price of share shall be treated as perquisite in the hands of employee and will be taxable under salary head of income tax act 1961.

Income in the hands of employees can be roughly calculated as below:-

* Income (Perquisite) in the hands of employee = Market price of company’s share Less price agreed to be paid by the employee.

There are two types of ESOPs:-

• Selective Plans
• All employee Plans

Benefits of ESOP

Following are the key benefits of ESOP:-

1. It helps in reducing employee attrition by giving them ownership in the stake of the company.
2. It works as an alternate to high compensation package for Start-ups.
3. It gives employees a sense of trust towards the company by making them shareholder in the company.
4. It encourages the employees to work in best manner for the shareholders since the employees themselves hold share in company.
5. It helps in maintaining funds of the company as it is not an out-of-pocket cost to the company.
6. In case of eligible start-ups, certain tax benefits are also there for the company as well as employees.

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Hence, it is not incorrect to say that ESOP works as a win-win situation for both; the employee as well as the company.

Taxability of ESOP

As explained above, income arising from ESOP shall be taxable as a perquisite in the hands of employees, the taxation shall be governed by the provisions of section 17(2) of income tax act 1961.

Value of perquisite = Fair market value of the shares Less Amount recovered from employee

Fair Market value:-

The date taken for calculating the fair market value as referred above shall be the date on which the option is exercised by the employee.

(a) If the shares are listed on a *recognised stock exchange, the fair market value shall be the simple average of the opening and closing prices of the share on option exercise date.

*For all computations, if the share of the company are listed on more than one recognised stock exchange, then average price of stock exchange, on which the highest volume of trading in that share has been recorded, shall be shall be taken into computation of average price of the share.

1. If no trading occurs on stock exchange on the date of exercising of option, the data of opening and closing price shall be taken of the date immediately preceding and closest to the date of exercising of option.
2. Closing price shall be the price of last settlement on the recognised stock exchange which is being used for computing FMV on exercise date.
3. Opening price shall be the price of first settlement on the recognised stock exchange which is being used for computing FMV on exercise date.

Note:- If the stock exchange quotes buy price and sell price instead of single transaction price, Opening and closing price shall be the sell price of first and last settlement on the Stock exchange which is being used for computation of FMV.

(b) If share are not listed on any recognised stock exchange on the date of exercising of option,  FMV shall be the value as determined by the Merchant banker on the date of exercising of option or on any date not more than 180 days earlier from the date of exercising of option.

Example: 1

On 10^th April 2021, M/s ABC Ltd. gives its each employee an option to purchase its 10 shares at Rs. 120/- per share. The fair market value on that date was Rs. 210/- per share. Mr. Ram, an employee of the company, exercises its option to purchase the share on 30^th April 2021. On this date, the FMV was Rs. 300/- per share. Calculate the value of Perquisite in the hands of employee.

Solution:-Value of perquisite in the hands of Mr. Ram is equal to;

The FMV as on 30^th April 2021 minus Amount paid by Mr. Ram towards shares of the company.

= 10 shares x (300-120)

=10 shares x 180

= 1800 Rs.

Example 2:-

Following is the data given on 05^th Jan 2021 for M/s Apollo Ltd. Kindly compute the FMV for the purpose of valuing perquisite in the hands of its employees. Assuming that its employees exercises their option on 5^th Jan 2021

Solution:- Since the stock exchange 3 is not recognised stock exchange, it shall not be taken into consideration for computing FMV.

Out of the remaining two stock exchanges, most no. of shares is traded on stock exchange 1. Hence FMV shall be computed taking the data of stock exchange 1 into consideration.

*Since both buy price and sell price is quoted at the stock exchange, sell price of first and last transaction shall be used as opening and closing price of share.

FMV as on 5^th Jan 2021 = Average of opening price and closing price on Recognised stock exchange.

FMV as on 5^th Jan 2021=  (Rs. 141.00+Rs. 145.00)/2

FMV as on 5^th Jan 2021= Rs. 143.00/-  per share.

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Example 3:

M/s Vastu Ltd. has offered to issue ESOP to its employees 1 share each @ Rs. 75/- per share. The date of exercise of option is 30^th june 2021. Share of M/s Vastu Ltd. are not listed on any recognised stock exchange. However, the following data from is available from its merchant banker.

FMV as on 30^th Sep 2020(as determined by Merchant banker) is Rs. 160/- per share.

FMV as on 31^st March 2021 (as determined by Merchant banker) is Rs. 148/- per share.

FMV as on 05^th July 2021 (as determined by Merchant banker) is Rs. 180/- per share.

Further data of FMV as on exercise date is available from an unrecognized stock exchange is as follows:-

Opening price of share:- 155/- per share

Closing price of share:- 160/- per share.

Kindly help Mr. Aman, an employee of M/s Vastu ltd. in determining the FMV of their share.

Solution:- Since the share are not listed on any recognised stock exchange, the data available from merchant banker shall be used in computing the FMV of share.

As the option is exercised on 30^th June 2021, the FMV available on nearest date between 01-01-2021 to 30-06-2021 (i.e. within 180 days) shall be taken into computation.

Since 30^th Sep 2020 is not covered in above period, FMV of 31^st march 2021 i.e. Rs. 148/- shall be taken as FMV of shares for valuation purpose.

Note:- FMV on 5^th July 2021 cannot be taken into consideration as the only immediately preceding date  can be taken into computation not afterwards.