What HRs and companies need to know about ESOP
13 minutes read

What HRs and companies need to know about ESOP

In this blog, we will discuss what HRs and companies need to know about ESOP (Employee Stock Ownership Plan), reason, eligibility and types. Index: An Employee Stock Ownership Plan is an employee benefits plan that is used by all sizes of companies, such as blue-chip to start-ups. A company makes a plan to provide the benefits to their employees with the ownership interest. In other words, a company has to set up a trust fund, then the company has to contribute new shares of its stocks or borrow cash to buy existing shares, then the employee and other participants will receive the tax benefits from ESOP. And this plan is set by the company to allow the interest of the employees with shareholders. They help succession plans by allowing company employees the chance to buy stocks.

Employee Stock Ownership Plan

Employee Stock Ownership Plan (ESOP) refers to the employee benefits plan. That benefits plan offers the interest of ownership to the employee in a particular company where they are employed. And it is issued in three ways such as profit-sharing, direct stocks, and bonuses which are availed by the employee who chooses at the sole discretion of the employer. But, it is based on the employee’s designation, service tenure, pay scales and other details. 

Reason for offering ESOP to employees

Usually, the organisation offers and distributes the stocks under the ESOP in a systematic manner to attract and retain high potential employees. For example – the organisation allows the stock nearly of the financial year. Then, it will act as an incentive for the employees. Like this, the employees are bound to work with the employer throughout the year to receive the grant.  The company offers ESOP to the employees for long-term objectives. Because through the ESOP, they are able to keep their employees for a long time by making them shareholders of the organisation. By offering this plan in the company, they create a competitive, attractive compensation package. With that, ESOP offers a sense of ownership to the employees. With the feeling of ownership, employees work with an interest in the growth and well-being of the company, which shows the employee’s productivity.  The ESOP benefits employees and employers by purchasing shares of the existing owner, and it can be used to borrow cash at a lower cost. The company issues new shares and deducts the value from their taxable income.

Who is eligible for ESOP?

Under the Employee Stock Ownership Plan, except for promoters and directors of the company who have 10% of the equity in the company, every employee will be eligible. Also, an employee needs to meet any of the following criteria.  
  • A director of the company, whether part-time or full-time.
  • A permanent employee of the company will be eligible for ESOP working in India or Foreign.
  • A current subsidiary employee, holding or associates located anywhere in India or foreign.

What HRs and companies need to know about ESOP (Benefits for employer and employee)

There are numerous benefits to ESOP from the perspective of employer and employee –



It helps to boost the employees’ trust in the company’s management 

No need to bear upfront cost
Influences workforce for employer

Acquires companies’ shares at nominal rates

The employer shares a half portion of the interest of the overall profit of the company with the employees. 

An employee can enjoy a proportion of the company profits with the feeling of ownership.

It shows the loyalty of the employees’

Incentives in the form of handsome salaries

Startups are not affected or cash reserves of the small companies

They provide Job security and satisfaction for the employee.

Types of ESOPs

There are the following ESOPs that the organisations use to offer to the employees to purchase the number of shares on options for a certain period. But, for that, an employee needs to be part of the organisation until the stock options are exercised.  
  • Stock Appreciation Rights (SAR) 

Under the stock appreciation rights, employees are offered a number of shares of the organisation in principle that the employees can obtain the cash value, which is equal to the price appreciation on the allowed price. 
  • Employee Stock Option Scheme (ESOS)

Under this scheme, there aren’t any rules and obligations for employees. But, they have the right to exercise their shares at a predetermined price and time. Before vesting, the employee needs to complete the target. Then the employee can purchase the shares at a predetermined price.
  • Restricted Stock Award (RSA)

It is just opposite of the restricted stock unit. However, the difference is that the employee offers shares in the organisation along with voting rights and is entitled to dividend rights. But, the employees need to meet the predetermined terms and conditions that are set by the employer. If the employees are not able to meet the requirements, then they will not be eligible for the longer to obtain the shares. The condition set by the employer can depend on a particular period or target. And RSA can be purchased at a lower rate, and during the vesting period, the employee owns the shares from the first day and is eligible for dividends and bonuses. 
  • Restricted Stock Unit (RSU)

Under the Restricted stock unit, the employee has no voting right nor right to dividend, only can exercise the shares which are granted by the company after predetermined conditions met. And the restricted stock unit will not be transferred immediately to the employee. But the employee can be entitled to a partial dividend in future under certain conditions. 
  • Employee Stock Purchase Plan (ESPP)

An employee stock purchase plan is the plan or date and price at which the employee can buy the shares of the company predetermined by the plan term. And the employee can purchase shares below the market price usually, which is fixed at a discount rate.
  • Tax on Foreign ESOP 

According to the double taxation avoidance agreement (DTAA), international taxation laws are applied in order to avoid double taxation. If the employee holds foreign shares, then they will be treated as unlisted shares and taxed. And it depends on the tenure the shares are held, short-term capital gain or long-term capital gain.  
  • Tax Implications on ESOP-

Under the Employee stock ownership plan, employees are liable to pay the tax when they exercise their options and sell their shares. Mainly there are two cases of tax implications on ESOP-
  • Right to purchase shares

When an employee exercises their options, the profit will add to their salary and be taxed by the employer. If the company is listed in India, then the value of allotted shares will be treated as the average value of the fair market value. If the company is unlisted, then a certificate which measures the fair market value of allotted shares needs to be obtained from the merchant bank.
  • Right to sell acquired shares

When an employee is willing to sell their acquired shares at a higher price, then they will be responsible for taxes on a capital gain. Short Term Capital Gain (STCG) & Long Term Capital Gain (LTCG) taxes depend on the time duration of holding shares. Capital gain taxes will be applicable for gains that value more than Rs.1 Lakh and that are held for 1 year and more with the security transaction tax will be subject to 10% of LTCG. Similarly, the capital gain will not be applicable if the value is less than Rs.1 Lakh and held for less than 1 year with the security transaction tax of 15% of STCG. Whereas unlisted shares are held for 2 years with the indexation of 20% LTCG, then the long-term capital gain taxes will be applicable. If the unlisted shares are held for less than 2 years then, it will be treated as short-term capital gain taxes be applicable as per the slab rate. This is the end of our discussion on what HRs and companies need to know about ESOP. Let’s know your other questions and opinions on this topic. Mention below the comment box. Related Post: A guide to payroll process HR questions to ask in an interview Income Tax Act


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