You must have heard stories about employees becoming millionaires while working with a specific company? If yes, then its time for you to realise that they are not stories. These have happened and continue to happen with the help of a plan known as the Employee Stock Ownership Plan (ESOP).

ESOP is a scheme under which the employees are provided with the right to become shareholders of the organization in which they are working. This phenomenon of stock options is a system of mutual benefit which when applied in the right way ensures prosperity to the employer as well as the employee.

Understanding Employee Stock Ownership Plan (ESOP)

An ESOP (Employee Stock Ownership Plan) is an employee benefit scheme regulated through Section 62(1) (b) of the Companies Act, 2013 (CA, 2013) and the SEBI (ESOS and ESPS) Guidelines, 1999. With the help of this scheme, the employers offer ownership rights to the employees by encouraging them to buy shares of the organization. Generally, these shares are allotted to the employees at a cheaper rate than the prevailing market rate.

The ESOPs are most often used by the startup companies to help them get on board the best talents and retain them. As these budding companies fail to provide high salaries to the employees, they offer them the company’s share as a compensation package. In this way, the employer shows the willingness to share the organization’s future prosperity and success with the employees. In many cases, the employer offers stocks or shares to the employee that can be functional on a future date to make sure that the employee keeps working for a long-term in the company.

Are all employees eligible for ESOP?

Generally, all employees belonging to a specific organization or company are entitled to the benefits under the ESOP. But, the organizations have made certain regulations to determine which employees will be eligible for this scheme. The benefits entitled under the ESOP scheme can be claimed by:

  • Any employee, working in or outside India who has been verified as a permanent employee by that company
  • A full-time or a part-time director of that company
  • An employee belonging to a holding, associate, or subsidiary company, working outside or in India.

However, the directors or promoters of the company who hold more than 10 percent of the equity shares of that organization are eligible for ESOP only if the company is recognised as a start-up by DPIIT.


Benefits of ESOP

Employee Stock Ownership Plan (ESOP) has been fabricated in a way that offers several benefits to the employer as well as the employee. Let us study the benefits from both the company’s and the employee’s side to form a better understanding.

From the employers perspective

Generally used by startup companies, the ESOP is used as a tool to hire well-qualified employees and retain them for the company’s prosperity. When the employer provides an employee the right to become a shareholder, it promotes an ownership interest among the employees. This helps them to work harder and put in more effort into the well-being of the organization which will automatically lead to an appreciation of the value of the shares.

Various studies have also shown that when the ESOP is exercised in a company, the employees show more loyalty which helps them to work as a motivated workforce. Besides, this scheme also becomes a great way to reward the employees without having to pay them high salaries in the beginning. This allows startup companies to use liquid cash for some other necessary purposes.


From the employees perspective:

Although the employees do not make good money when hired by a startup, the employees get the advantage of acquiring shares or stocks of the organization at a comparatively cheaper rate. This helps the employees to make less investment and earn more in the process, promoting overall wealth generation. It also helps the employees in planning a comfortable retirement.

Moreover, when an employee becomes the company’s shareholder, he starts to feel that he is a part of the company and that makes him actively participate in the important discussion associated with the well-being of the organization. With the help of ESOP, the employees can also enjoy better job satisfaction and job security.


Tax Implications associated with ESOP

According to tax laws, ESOP attracts taxation. This implies that the employees have to pay taxes once the shares are allotted by the organization. Mentioned below are two instances when ESOPs attract taxation:

  • At the time of exercising the share allotment: In this case, it is considered as a prerequisite and is, therefore, taxable. The difference between the exercise price and the Fair Market Value (FMV) on the specific date of exercise is taxed as perqusite. FMV is the rate at which the shares were purchased by the employee.


  • At the time of selling the shares: An employee may want to sell the shares he bought. If the shares are sold at a price higher than FMV on the exercise date, the employee will be accountable for capital gains tax. The period of holding of the shares determines the amount of capital gains tax.

However, since the shares sold by the startups are generally unlisted, the employees find it hard to sell them and receive cash in the process. This leads to a crisis as the employee receives a reward in the form of shares, not cash and then, needs to pay extra in the form of tax.

Keeping a note of these challenges faced by the employees, a proposal has been made in Budget 2020 to relieve the employees from paying taxes in the future years. As per the proposal, the shares allotted by an eligible startup organization shall be liable to taxation at the earlier of the below-mentioned events:

  • Resignation of the employee
  • The time when the employee sells the stock option
  • Completion of a period of four years from the end of the year in which the shares or stocks were allotted by the company


The taxes will be deducted by the employer within a span of fourteen days in case any of the above-mentioned incidents take place. However, even if the taxable event is postponed, the tax to be paid will be computed according to the tax rate applicable for the employee during the year of allotment. This is done to ensure that the employee does not get any benefit or face any demerits owing to the change in tax rates.

Head over to FinGurus to learn everything about the new tax rebates and changes to the ESOP laws and make it easier for you and your employees to own stock options.