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As per reports , currently, about 3.32 billion people are employed around the world. No matter the size or industry of a company today, employees are important stakeholders. Initially, the biggest requirement for any employee of any company was to get due compensation for their hard work and efforts. However now, with the changing times, the requirement has gone beyond the basic monetary compensation and now extended to better benefit plans for the employees to keep them motivated. The most recent addition to the new employee package is Employee Stock Option Plan or Employee Stock Ownership Plan (ESOP).

To understand this better, let us look into ESOP,

ESOP: Explained 

ESOP is a customized benefits plan for all employees wherein they get the opportunity to participate in company ownership in the form of direct stock, profit-sharing bonuses, or profit-sharing plans. In simple words, ESOP is a plan that is designed to offer the employees, a portion of the stock or some shares of the company. The stock offered is at a price lower than the market price and the company or employer has complete decision-making authority to decide which of the employees can avail  the ESOP option.

The main purpose of ESOP is to allow employees to use the credited stock by the company for encashment or share purchase after a given time and a pre-set price. Some of the top companies offering ESOP to employees in India include Myntra, Flipkart, Amul, J Thomas & Co. Pvt. Ltd., etc. The employers need to follow all the required regulations curated by Companies Rules to grant ESOP to any of the employees.

How Does ESOP Work? 

Now that you are well aware of what an ESOP is, let us now dive into how an ESOP works. ESOPs are offered by companies to some employees based on service terms, pay scale, grade, and many other aspects. The decision of which employees receive this benefit plan is solely on the employer. The process of ESOP begins as follows.

  1. The first step involves only the employers wherein they discuss and finalize the number of company shares that can be offered as ESOPs to the employees. Along with this, they also finalize the share price that will be offered to the employees for purchase.
  2. Once these two aspects are finalized, the employer then decides on the employees that are to be offered the ESOP grant.
  3. The said list of employees is then granted the ESOPs.
  4. Once this process is completed, the ESOP offered to the employee is put into a trust fund for a said period, known as the vesting period. The vesting period is the required employment tenure for an employee with an ESOP, to be able to avail the complete ownership of the purchased stock using ESOP.
  5. As soon as the vesting period for an employee is completed, also known as the vesting date, they have the right to use that ESOPs and buy the shares of the company at the given prices, which were lower than the market price.
  6. Employees also have the opportunity to buy or sell the company shares using ESOP to make a gain on their portfolio.
  7. However, if the employee resigns or retires from the company before the vesting date, the employer is required to purchase the granted ESOP back from the employee at a reasonable value within a maximum of 60 days from the date of resignation/ retirement.

Top Benefits Of ESOP 

As opposed to other benefits offered to employees today including health care compensation, paid leaves, paid holidays, etc., ESOP was introduced to fulfill the long-term goals and objectives of an organization. The main reason why ESOP is offered by any company to the employees is to retain them within the organization, whilst attracting a quality talent pool.

An ESOP benefits both the employer and the employees. Now, we will discuss the individual benefits of ESOP for the employee and the employer below. 

For Employees

  • One of the main advantages of ESOP for an employee is part ownership within the organization as they will be holding a certain number of company shares as per their level.
  • The other advantage of ESOP is the possibility of earning good dividends from the organization, adding up to their existing income.
  • Employees also get to purchase the company’s stock at a lower discounted price than the market value, making it more accessible and profitable for them in the long run.
  • It is considered a smart and strategic step towards employee motivation and retainership, as most companies plan the issuing of ESOP closer to the end of any financial year. This acts as a great turn point for any high-quality employee that might be planning to resign or retire but they refrain from the same.

For Employers

  • The employers, on the other hand, benefit from the inflow of top-level quality talent due to the availability of ESOPs for the company employees. In addition to that, companies with lower capital can benefit from offering a more well-curated salary package using the addition of ESOP.
  • As the main purpose of ESOP is to keep the employees of the company motivated, the employer will benefit from improved productivity and efficiency from all the employees as they will be performing at their best to avail this advantage.
  • It is considered a smart and strategic step towards employee motivation and retainership, as most companies plan the issuing of ESOP closer to the end of any financial year. This acts as a great turn point for any high-quality employee that might be planning to resign or retire but they refrain from the same.
  • Companies that want to offer the best working environment to their employees and reward them for their exceptional performances also use ESOP to make the best employees active stakeholders within the organization. This not only has a direct positive impact on the employee’s performance but also spreads a positive image of the company in the market.
  • Lastly, as the competition in the market is rising rapidly, with the help of an ESOP, employers can effectively retain their top employees, without exceeding budget. Additionally, as the ESOP comes with the vesting period, the employees will be encouraged to stay put with the employer until the vesting date.

Types of Tax Implications

When it comes to the key tax implications for all employees and employers that receive or give out ESOPs, these are the two main points to remember:

  1. The first type of tax is levied when the employer allots a set number of company shares to any employee once the vesting period is over. The amount eligible for tax is calculated using the difference of price of these shares in the market and the price given to the employees once they reach the vesting date.
  2. The second type of tax is levied at the time of sale of the distributed shares by the employee under ESOP. These allotted shares are considered capital assets and thus further attract capital gain tax upon sale of the same. There are two types of capital assets including short term and long term. The shares that are not listed for longer than 24 months are considered long term capital assets whereas the ones sold before this time period are called short term capital assets.

Final Thoughts 

ESOPs have now attracted multiple companies from around the world. The most important thing to remember for any company or employee that wants to give or receive an ESOP is to understand what it is, how it works, and exactly how you will benefit from the same before committing. As an employer and employee, you also need to look into the possible tax implications and liabilities in the case of ESOP. Do note that not all ESOPs are of the same category so be aware of the different types and their benefits before offering it to your employees or taking it from your employer.