ESOPs are employee benefit plans which offer the employees’ ownership rights of the organization in which they work.

Today, the employment market has become highly competitive. Thus, organizations keep introducing new ways to offer benefits to the employees in a bid to attract and retain good talent. ESOP is one such popular employee benefit plan offered by corporates and other organizations throughout the world. 

Are you being offered ESOP by your company? Do you want to know what exactly ESOP is, and what the probable benefits you will get from it are? We have got you covered. Here, in this article, we will explain, in complete detail, what ESOP is, how it works, its benefits, as well as its tax treatment. So, keep reading to learn all about this employee benefit plan and gain the clarity you need to decide whether you should accept it or not.

What Is The Meaning of ESOP?

The full form of ESOP stands for Employee Stock Ownership Plan (ESOP). It is a plan dedicated to benefiting 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 certain amount of time.

How Does ESOP Work?

At first, the company decides the number of stocks they are willing to share and the names of the employees to whom they are going to offer it. After the decision is made, they grant the stock to the employee along with a grant date. Employees cannot avail themselves of the ownership of the offered stock before the specified grant date; until this time, the stock stays in the trust fund. The time period in which it remains in the trust fund is called the vesting period.

After the vesting period is over, employees can obtain ownership of the stock by employing the ESOPs. They can buy them at the assigned prices, which are substantially lower than the fair market prices, and gain complete ownership of the stock. From then on, it is the employee’s choice to retain the stock or to sell it at market price and gain wealth from the asset. 

In case the employee does not complete the vesting period and leaves the organization early, then the organization will re-purchase the ownership interest from the employee at the market price. 

What Are The ESOP Taxation Rules?

ESOPs are becoming common 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 taxation rules of ESOP. 

Tax is imposed on ESOP 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 market price and the exercise price. The exercise price is the price at which you buy the stock from the company and exercise your ESOP. 

In the first case, when you exercise your ownership interest, tax is implied on the difference between the exercise price and the market price. The employer cuts TDS 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 on which it was exercised.  

What Are The Benefits of ESOP For Employees?

ESOP benefits both the employer and the employee. Some of the benefits that the employees get from ESOPs are:

  • A chance to buy the company’s stock 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. 

  • 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 the employees. It gives them an ownership interest in the shares of the organization. Employees can buy these shares at a price lower than the market price after the completion of the vesting period. The employee can either choose to retain the shares or sell them – it is completely the employee’s choice.

Frequently Asked Questions

Are ESOPs safe in startups?

A startup has an equal probability of becoming highly successful or turning into a drastic failure. So, agreeing to ESOPs in startups can be a gamble, especially because the company’s stocks can lose their value at any time.

How are ESOP stock prices determined?

ESOP stock prices are determined by several factors, including the present performance of the projects of the company, the expected future performance of the company, and the place where the company is situated.

What are the employer benefits in ESOP?

The benefits of ESOP for an employer are: better employee performance, and a better employee retention rate for the organization.

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