income tax
Employee Stock Option Schemes (ESOPs) have emerged as a prominent strategy for attracting and retaining talent within organizations. As the workforce is fundamental to corporate success, incorporating ESOPs into employee compensation plans fosters a sense of ownership and commitment among employees.
ESOPs gained traction in the IT sector during the early 2000s and have since spread to industries such as pharmaceuticals, retail, and startups. Financial institutions, including banks, are gradually adopting ESOPs to retain high-caliber employees.
For unlisted companies, buyback options based on valuations are the primary method for ESOPs, as there is no available open market. Conversely, listed companies must adhere to the Securities and Exchange Board of India's (SEBI) Securities-Based Employee Benefit (SBEB) & Sweat Equity Shares Regulations, 2021, as amended, which stipulate specific conditions for granting and allotting ESOPs.
The ESOP process begins with identifying eligible employees and granting options. Following the vesting period, employees can exercise their options by paying the specified exercise price to the company.
It is important to reference SEBI regulations, specifically regarding the Prohibition of Insider Trading (PIT regulations), as exercising options is excluded from acquisition criteria and trading window prohibitions. Designated Persons, identified based on their functional roles, may exercise their ESOPs, subject to the company's internal policies.
Pre-clearance provisions and disclosure requirements under Regulation 7 apply if trading turnover exceeds the prescribed threshold within a quarter. ESOPs can be implemented through two main avenues:
For a listed company to implement ESOPs, several prerequisites must be met:
Although regulations do not specify a mandatory lock-in period beyond the minimum vesting schedule of one year, ESOPs are typically structured over a timeline of three to five years to effectively attract and retain talent.
Taxation plays a crucial role in the administration of ESOPs. Individual taxpayers often advocate for a reduction in the tax burden associated with ESOPs. Unlike phantom stocks, which incur a single point of taxation, ESOPs are subject to multiple tax events.
According to the Income Tax Act, 1961, the exercise of ESOPs marks a taxable event. The tax liability arises from the difference between the Fair Market Value and the Exercise Price, which is subject to Perquisite tax. Subsequent sales may incur either a 20% tax rate on short-term gains or a 12.5% tax rate on long-term capital gains exceeding ₹1.25 lakhs, as stipulated in the new tax regime per the Finance Act, 2024.
An attached Excel sheet provides guidance on calculating the perquisite tax and understanding the tax implications associated with the exercise of ESOPs. The sheet includes a snapshot of pre- and post-exercise tax impacts as well as the Break-Even Price.
This overview aims to provide a foundational understanding of Employee Stock Option Plans and relevant legislative considerations. Please note that tax laws are continually evolving, and the calculations provided in the attached Excel sheet are for illustrative purposes only. They should not be relied upon for decision-making. Compliance with current regulations and seeking professional advice is strongly recommended.