The Emergence of ESOPs in India
India is the third-largest startup ecosystem in the world and it attracts all kinds of global investors. This is evident with the huge expansion India has seen in the recent past with regards to the list of ‘unicorn’ companies that have come into existence. A unicorn refers to a startup that gains value of over $1 billion. This brings into the picture Employee Stock Option Plans (ESOPs) to ensure that all the employees of the company have the same goal which—to increase the performance of the company, which in turn makes it more profitable.
Employee Stock Option Plan and Regulatory Framework
An Employee Stock Option Plan (ESOP) in India is an incentive granted to employees of a company to buy or subscribe to shares of the company at a predetermined price for the future. The software industry was the first to bring about this plan because of the “brain drain” and poaching of high performing employees. Employees want more than just a salary because they need the incentive to stay on with the same company and not move jobs as easily. Ownership of part of the company gives employees a sense of belonging as well as an incentive to continue their employment long term.
Employee Stock Option was first introduced by way of clause 15A in section 2 of the Companies Act, 1956. It defines what an employee stock option is and enumerates the conditions that need to be fulfilled for the issue of such shares. The Securities and Exchange Board of India (SEBI) which is the governing body for ESOPs and Employee Stock Option Schemes (ESOS) set guidelines in 1999. Section 62 of the Companies Act, 2013, further incorporates enabling provisions for the issue of ESOPs subject to the sanction of a special resolution and compliance rules (in case of unlisted companies) and SEBI rules (in case of listed companies).
Employee ownership plans in India are simply stock option plans. Approximately 68% of listed companies, and 29% of unlisted companies, give ESOP benefits to their employee amounting to one time the cost to the company. Unlisted companies issue ESOPs to retain employees and give them an incentive for when stocks are listed which will unlock the value and give a high potential for great earnings. Listed Companies use it mostly as a rewarding tool. Indian employees exercise the vested option early with 90% of them doing it within 2 years. This may be because of the taxation laws which state that if an employee holds shares of a listed company for more than a year, the capital gains are tax-free.
Indian ESOP Statistics
As per a survey, 43% of IT companies in India have given ESOPs to more than 90% of its employees but only 17% of Non-IT companies have done the same. More than 75% of non-IT companies offer ESOPs only to senior and middle management employees. A study in 2001 shows that within IT companies only 23% of the large companies offer ESOPs to more than 90% of their employees and only 60% in the case of small companies. A significant 54% of large IT companies offer ESOPs to less than 25% of their employees.
How Indian ESOPs Works
The above shows the general outline of a stock option plan. An employee gets the grant and has to wait a minimum of one year until the shares vest. After which they can exercise and sell the option at any time depending on the market rates. There is no minimum or maximum limit for exercise and sale of shares. These ESOPs are not transferable and only the employee shall be entitled to exercise the options. The guidelines state, upon the death of the option holder, while he was an employee, all options granted to him including unvested options, shall vest in his legal heirs on the date of his death, and they shall be able to exercise it. This also holds if he was not an employee at the time of his death but had options. Buy-back of shares does not have clear regulations. The guidelines prohibit the transfer of stock options, buyback through negotiated deals, or private arrangements.
Taxation Policy and Future Changes
The tax implications of ESOPs in India are usually at 2 instances. Firstly, at the time of exercise after the vesting period when the shares are allotted to the employee. This is calculated as the difference between the fair market value of shares on the date of exercise and the exercise price paid by the employee. Secondly, when an employee opts to sell the allotted shares under ESOP. This is the capital gains tax on ESOP. The Department for Promotion of Industry and Internal Trade (DPIIT) is looking into the taxation policy of ESOPs because they want to foster a better growth environment for industries, especially startups. They want to propose that employees get taxed only at the time of selling shares and not at the time of vesting. Since this is used as a tool to promote ownership and retaining of employees, so much tax is bringing down the benefits. Hence the DPIIT is planning on doing industry-wide research and will look into all practices followed and the pros and cons of investor’s tax department and industry point of view. This will be most beneficial for all individuals and companies, especially startups.
1. ESOPs Back in Fashion
2. Regulatory Framework for ESOPs in India
3. ESOPs in India How Much Do You Know?
Pooja Kumar, Graduate Student Associate, Beyster Institute