ESOP (Employee Stock Option Plan) Provisions & Procedures

1. ESOP (Employee Stock Option Plan) Provisions& Procedures taxguru.in/company-law/esop-employee-stock-option-plan-provisions-procedures.html May 21,2022 Introduction Employee stock option plan (ESOP) or Equity incentive plan is the scheme used by the companies to give ownership interest to its employees. ESOP is regulated by Section 62(1) (b) of the Companies Act, 2013and SEBI (ESOS and ESPS) Guidelines, 1999.The latest amendments in the guidelines were given by the SEBI in 2014followed by an amendment in2015. In this blog post we shall discuss the Employee Stock Option Plan and thevarious provisions related to thesame. What isESOP? ESOP or Employee Stock option Plan is an employee-owner method which provides ownership stake to its employees. This method is used by the organization to attract, encourage and retain its employees. The employees are given an option and it doesnot obligate the employee to accept thisscheme. An ESOP is an option given to its whole time directors and permanent employeesthe benefit or the right to purchase the stock of the company at a predeterminedprice. Benefits ofESOP It keeps the employees motivated as direct stakes areinvolved. It is a ‘kind’ payment, instead ofcash. It gives a sense ofownership.

2. Thus giving ESOPs to employees helps the companies and even start-ups toattract potential employees, to retain and motivate theemployees. Who is anemployee? According to the guidelines provided by SEBI an employeeis:- A permanent employee of theCompany A director of the company An employee of asubsidiary An employee does notinclude An employee who is the promoter or an employee of the promoter group(an immediaterelative) A director who owns directly or indirectly more than 10% of the equity shares ofthe company. All the listed companies are regulated by the SEBI (ESOS and ESPS) Guidelines,1999 and all the unlisted companies are regulated by the Rule 12 of Companies(Share Capital and Debenture) Rules, 2014. The ESOPs can be issued through tworoutes EquityRoute TrustRoute EquityRoute In this route the company issues equity shares of the company to the employees asand when they exercise theoption. TrustRoute In the trust route the company forms an Employee Welfare Trust for the administrationof ESOP in the company. The company issues shares to the trust which is forwarded or transferred to the employees upon exercise ofoptions. Procedure followed for the formulation of ESOPs through equityroute Step 1- Constitution of Compensationcommittee Section 5 of the guidelines provide for the formation of a compensation committee. A compensation committee is formulated by the board of directors (BOD) and consist ofa majority of independent directors. The Board of directors can also choose a merchant banker, however it is optional. This committee is set up to formulate detailed terms and conditions for theESOP. Step 2- Framing of theplan

3. The Compensation Committee frames a plan. The plan must be in accordance with the guidelines provided by SEBI. The Compensation committee is for the administrationand superintendence of the ESOPplan. Step 3- Presentation to the BOD andapproval After formulation of the plan by the compensation committee the BOD approves the plan. In case the company is listed, the plan should have an approval from the respectivestock exchange. Step 4- Approval ofShareholders The shareholders approve the plan through a special resolution. The plan should be approved by a majority of 3/4thShareholders. A separate resolution should be passed if there is grant of ESOP to employees of any subsidiary or holdingcompany. Step 5- All necessaryinformation The shareholders should be provided with all the documents necessary for them to formulate an informed decision. The explanatory details shall disclose prescribed statements like number of shares issued, amount at which issued, lock-in period,exercise period, method of accountingetc. Variations in the terms ofESOP The company shall not vary from the terms of ESOP approved in any manner thatwill result in the detriment of the shareholders. The notice of variation should be given tothe shareholders containing all the details of the variation and should also contain the employees who will be benefitted by thevariation. The variation should be approved by a special resolution in the general meeting.The option of reprising of the shares is given to the company if it is not detriment tothe interest of the employees and theshareholders. Lock inperiod Their shall be a maximum of one year of lock in period. The employee cannot enjoyany benefits of a shareholder like share in dividend or voting right until shares are issued on exerciseoption. Transferability of shares The shares are not transferable. The employee cannot alienate the share in anymanner. In event of death of an employee the shares shall vest to the legal heir or the nomineeof thedeceased. In case of resignation or termination of the employee, all the rights vested in him canbe retained. The plan should specify the time period within which the employee canexercise his option. An employee terminated in case of misconduct will not have any vestedright

4. in the issuedshares. Valuation of StockOption There are two methods used in the valuation of the stockoption. Intrinsic valuemethod Fair valuemethod Intrinsic ValueMethod Intrinsic value is the value at the date of grant. For example: if the market value of ashare at the time of grant is ₹150 and the shares were issued at ₹100, the intrinsic value of each share will be ₹50 which should be shown by the company as a compensation expense. If the shares were issued at ₹170, the intrinsic value will become -20 which need notbe shown. Fair valuemethod In this method if the market value of each share is ₹150 and the shares are issuedat ₹170, the fair value of each share will be ₹20. In this method the employee has the right to purchase the share at a future date when the market value of each share is morethan ₹170. In Intrinsic value method the employee has no option to buy shares at a laterperiod. Companies can choose from any of the above method. However, they have to disclose it in the general meeting and should also follow the accounting guidelines provided bySEBI in guidelines of2014. Taxation ofESOP Income tax should be paid in twosituations At the time of givingESOPs The income is treated as perquisites which form part of the salary of the employee.The employer is required to deduct TDS and the income is calculated as the difference between the fair value of each share and the marketvalue. At the time of sale ofESOPs The gains arising out of ESOPs are capital gains. The capital gain is the difference between the sale price and the price at which it was awarded to the employee. Thetax should be paid in the year of the sale ofESOP. Long Term– When the ESOPs were held by the employee for more than 36 months(3 years) from the date of purchase the capital gain tax rate is20%.

5. Short Term– When the ESOPs were held for less than 36 months (3 years) from thedate of purchase the capital gain tax is10%. Disadvantages ofESOPs The main concern for ESOPs is dilution. With every share granted to the employeethe shareholders share getsdiluted. Conclusion ESOPs have proved to be very effective tools for both big companies andstart-ups. Companies use these to retain their workforce and the talent whereas start-ups usethese tools to hire fresh talent and to attract more workforce. These work as a boon for companies which cannot afford to pay high salary. Besides this the sense of ownership acts as a motivation for the employees to work hard anddiligently. Tags: Companies Act, Companies Act 2013,ESOP Kindly Refer to Privacy Policy & Complete Terms of Use andDisclaimer. AuthorBio Name: NirmalJoshi Qualification: Post Graduate Company: N/A Location: Mumbai, Maharashtra,India

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