Employee Stock Option Plan [ESOP]

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    An ESOP, or Employee Stock Ownership Plan, is a program that grants workers a stake in the company. These plans provide employees with company stock directly, through profit-sharing, or as bonuses. The decision to offer these benefits rests entirely with the employer, who also determines eligibility. ESOPs represent options to buy shares at a predetermined price before a set date. Employers must adhere to specific rules and regulations outlined in the Companies Rules when allocating ESOPs to their workforce.

    How does it Works

    An Employee Stock Ownership Plan (ESOP) enables employees to acquire a certain number of company shares at a predetermined price after a specified option period. To exercise this option, employees must complete a vesting period, which requires continued employment until they’re eligible to claim part or all of the options.

    Through ESOPs, employees have the opportunity to buy company stock at a price below market value. They can also sell their acquired shares at a profit.

    Should an employee depart or retire before completing the vesting period, the company is obligated to repurchase the ESOP shares at the current market price within a 60-day timeframe.

    Cost and distribution of ESOP

    The initial expenses of an Employee Stock Ownership Plan (ESOP) in India can encompass legal, accounting, and administrative costs.

    The investment for setting up and maintaining an ESOP can differ, depending on the plan’s scale and intricacy.

    ESOP distributions in India can take place through various methods.

    Employees may exercise their options to buy shares, choosing to either sell immediately for a quick profit or hold onto them for a potential value increase.

    Upon sale, employees receive the net proceeds after tax deductions on any profits made. If they retain the shares, they become part-owners of the company, potentially earning dividends or benefiting from capital gains with rising stock prices.

    Why do companies offer ESOPs for employees?

    Companies provide ESOPs to employees as a strategic move to attract and keep top talent. They typically allocate stocks gradually, often at the fiscal year’s end, to motivate employees to stay on board for the reward. ESOPs reflect a company’s long-term vision.

    The goal is not just employee retention but also to transform them into company stakeholders. This is particularly relevant for IT firms facing high turnover rates; ESOPs can be an effective tool to reduce attrition. Start-ups, usually limited in cash, use stock options to lure skilled professionals, thus enhancing their overall compensation offerings despite not being able to pay high salaries.

    From employee views

    From an employee’s viewpoint, ESOPs offer the chance to buy company shares at a minimal rate and sell them post a specified period determined by the employer, potentially yielding significant profits. There are numerous instances where employees have amassed wealth alongside company founders. A prominent case is Google’s IPO, which propelled its founders, Sergey Brin and Larry Page, to immense wealth, and even employees holding stocks made substantial earnings.

    Taxation on ESOP

    ESOP Taxation involves two scenarios:

    1. Acquiring Company Stock: When employees exercise their ESOPs, they buy shares at a price below the Fair Market Value (FMV) on the vesting date. The difference between the FMV and the exercise price is taxable as per the employee’s income tax bracket.
    2. Selling Acquired Stock: Profits from selling the shares, calculated as the difference between the sale price and the FMV at the time of exercise, are taxed as capital gains.

    Tax levied while buying 

    For start-ups, the tax on the benefit from exercising ESOPs is deferred to the earliest of:

    • Five years post-ESOP grant
    • Sale of the ESOP
    • Employee’s exit from the company

    Tax levied while selling 

    Capital Gains Tax specifics:

    • Selling within a year: 10% tax on gains exceeding Rs.1 lakh
    • Selling after a year: 15% tax on profits

    Foreign ESOPs in India follow similar tax rules, with taxation on perks from an overseas company.


    To be eligible for an ESOP, the employee must satisfy certain conditions such as completing a minimum tenure with the company, meeting performance criteria, or being part of a particular grade or level within the organization.


    1. Determine the number of shares to be offered to employees
    2. Set a vesting period for the shares
    3. Establish exercise price for the shares
    4. Create an ESOP trust or identify an existing one
    5. Develop a communication plan to educate employees about the plan

    Documents Required:

    1. Board resolution to approve the ESOP
    2. ESOP agreement between the company and the trustee
    3. Grant letter to employees outlining the terms of the ESOP
    4. Trust deed between the trustee and the company

    Benefits for employees in ESOPs

    ESOPs serve as a strategic incentive for employees within an organization. They align employee interests with the company’s success, as rising share prices directly benefit the workforce, encouraging full dedication to the company’s growth. Beyond motivation, retention, and recognition of effort, ESOPs offer additional significant benefits to employers. They allow companies to conserve cash by substituting direct compensation with stock options. This is particularly advantageous for businesses that are scaling up or expanding, making ESOPs a more practical choice over cash bonuses.

    ESOPs when shared listed

    When a company transitions from unlisted to listed, ESOPs undergo significant changes. For unlisted companies, selling ESOP-acquired shares can be challenging due to limited buyers and the FMV being set by merchant bankers. Capital gains are taxed similarly to debt funds.

    Shares sold within 36 months of exercise are subject to short-term capital gains tax at the individual’s income tax rate. Conversely, sales after 36 months are considered long-term and taxed at 20% with indexation.

    Listing the company opens up more avenues for employees to liquidate their shares, and the FMV then fluctuates with the market.

    • ESOPs are used to attract and retain high-quality employees, aligning their interests with the company’s success and offering a competitive compensation package.

    • Employees who meet certain conditions such as completing a minimum tenure with the company, meeting performance criteria, or being part of a particular grade or level within the organization are eligible for an ESOP.

    • The exercise price of the shares is typically set at a discount to the market price of the shares, usually between 10% to 20%.

    • The vesting period for ESOPs varies from company to company but is typically between 1 to 4 years. Once the shares have vested, employees can exercise their right to purchase the shares.

    • If an employee leaves the company before the vesting period is over, they typically forfeit their right to purchase the shares under the ESOP. However, some companies may have provisions for early exercise or accelerated vesting in certain circumstances.

    • There are two tax events: when employees exercise their options and when they sell their shares. The difference between the Fair Market Value and the exercise price is taxed as income, while profits from selling are taxed as capital gains.

    • Once a company is listed, selling shares becomes easier, and the Fair Market Value is influenced by market changes. Taxation on capital gains also applies differently.