Esops better than stock purchase plans

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The Financial Express

Shankar PB
Senior Manager, Tax, EY India

Companies often reward their employees with their stock, either in the form of employee stock option plans (Esops) or employee stock purchase plans (ESPPs). Esops are stock options granted to employees over a vesting period, where the employee is given the right to purchase the company’s shares at a predetermined price or the exercise price. If the employee does not exercise the option within a time prescribed by the company, the option automatically expires.

ESPPs allow employees to use their salary to purchase the stock of the company, usually at a discounted price. Unlike Esops, ESPP holders do not have any option, but are mandated to pay the exercise price usually by way of monthly deductions from their salary.

Employees can realise the benefit by selling the shares in the market, subject to a lock-in period, which starts from the date of the grant for Esops and, for ESPPs, from the date of allotment of shares. While the minimum lock-in period for listed shares is one year, a company may choose to extend it.

Both schemes have the following tax implications for an employee:

At the time of receiving the shares. The value of the shares after deducting the price paid by the employees is taxed as salary income at normal tax rates. In case of Indian listed shares, the value for tax purposes is based on the traded price in the stock market (on exercise), and, in other cases, it is left to the discretion of the prescribed valuer.

On holding the shares. Dividends received for shares of the Indian companies are exempt from tax in the hands of the employees/shareholder.

At the time of sale. Any gain beyond tax value of the shares may be subject to capital gains tax, depending on whether the shares are listed in India and the period of share holding. For listed shares where the securities transaction tax is paid, there would be no tax if shares are held for more than one year, but taxed at 15.45% if held for less than one year. In case of unlisted shares, the tax rate is 20.3%, if held for more than one year; if held for less than a year, it is taxable at normal rates of taxes (based on the income slab).

While ESPP holders have the facility to mobilise savings on a periodic basis and enjoy the shareholder benefits before Esop holders, Esops generally score better, more so in case of increase in share prices, as Esop holders’ cost would be pre-fixed at the time of grant (where the prices are lower). For ESPP holders, on the other hand, the average price would increase with each subsequent allotment. Esop holders are also protected from the downside by providing them the option of opting out when the expected market price is less than the exercise price.