What are ESOPs? Definition, Taxation Rules, Benefits, and More

Today, the employment market has become highly competitive. Thus, organizations keep introducing new ways to offer benefits to employees in a bid to attract and retain good talent. One such popular employee benefit plan that companies worldwide offer is ESOP. ESOP stands for employee stock ownership plan. Is your company offerings you ESOPs? Do you want to know what ESOPs are and the probable benefits you will get from them?

In this article, we will explain what ESOP is, how it works, its benefits, and ESOP tax treatment. Learn more about this employee benefit plan and gain the clarity you need to decide whether to adopt it.

What are ESOPs?

The full form of ESOP is an employee stock ownership plan. An ESOP benefits the employees of an organization by providing them with an opportunity to have an ownership interest in the stocks of that organization. With this ownership interest, the employees don’t have to incur additional costs for buying stocks from the organization. Even if, in some cases, there are additional charges, they are very low. Employees can encash these stocks after a decided period.

How do ESOPs work?

Here’s how ESOPs work in India generally. The company starts by deciding the number of stocks they are willing to share and the names of the employees who are eligible to buy them. Then, they grant the stock to the employee along with a grant date. Employees cannot avail themselves of the ownership of the offered stocks before the specified grant date. Till then, the stocks stay in the trust fund. This time is called the vesting period.

Based on the ESOP rules, employees can obtain ownership of the stocks after the vesting period is over. They can buy the stocks at the assigned prices, which are typically substantially lower than the fair market prices. From then on, you can choose to retain the stock or sell it at market price and gain wealth from the asset. 

Suppose you do not complete the vesting period and leave the organization. In that case, the organization will re-purchase the ownership interest from the employee at the market price. 

What are ESOPs taxation rules in India?

Various Indian companies are offering packages to employees in the form of ESOP. But before you accept the offer, you should know all about the taxability of ESOPs. 

Tax on ESOPs is applied under two circumstances: 

• When the employee buys it from the company.

• When the employee sells it to gain wealth from their holding.

In both cases, there are tax implications, and the tax amount depends on the ESOP exercise price and market price. The exercise price is the price at which you buy the stock from the company and exercise your ESOP. 

The difference between the ESOP exercise price and the market price is taxable in the first case. The employer cuts tax deducted at source (TDS) on ESOPs from the employee’s perks, which is reflected on Form 16.

In the second case, when you sell the stock to gain capital, tax is imposed on the difference between the selling price and the market price of the share on the date when it was exercised.

Benefits of ESOP for employees

ESOPs benefit both the employer and employees. Some of the benefits employees get from ESOPs are:

• The chance to buy the company’s stocks at a lower price

When the vesting period is over, employees can buy the share from the company at a comparatively lower price than the market price. 

• shared ownership of the company

Employees get a chance to buy a share from the organization they are working in. They also get the chance to share the capital with them.

• Retirement asset

If the vesting period is long and the value of the stock grows substantially over time, then the value of the asset can get appreciated, thus supporting you in the days after your retirement. 

Final thoughts

ESOPs are plans dedicated to benefiting employees. It gives employees an ownership interest in the shares of the organization. If you want to know more about what are ESOPs and their features, read the FAQ section below.

Frequently asked questions