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  • Sakshar Law Associates

Employee stock ownership plan

Updated: Sep 3, 2022


Sakshi Shairwal

Sakshi Mittal


An ESOP - Employee stock ownership plan refers to an employee benefit plan which offers employees an ownership interest in the company. Employee stock ownership plans are issued as direct stock, profit-sharing plans or incentives, and the employer has the ultimate discretion in determining who should avail of these options.

Employee stock ownership schemes are frequently used by organisations as a method to recruit and retain high-quality workers. The stocks are allocated in a staggered manner by organisations. Firms offering ESOPs have long-term targets. Companies not only want to retain workers for a long time, they also plan to make them their company's stakeholders. Most IT businesses have alarming attrition rates, and ESOPs will help them minimise such heavy attrition by providing stocks to attract talent. With ESOPs, an employee takes advantage of the nominal rate of purchase of the company's shares and sells them and makes a profit.

From the perspective of the employee, such schemes help to create a sense of ownership and ownership of the employer business and to invest in its development and thereby encourage long-term commitment. An introduction to employee stock option schemes and similar benefits that are provided to their employees by private limited companies in India can provide valuable insights into current offers of corporate jobs.

Usually, neither advisors nor independent directors are eligible to participate in ESOPs. More significantly, a company's founders or promoters can not take part in an ESOP unless the company is a registered start-up under Indian law. If the aim is to encourage a company's founders or promoters to engage in certain stock benefit schemes, alternative mechanisms will need to be embraced by companies.

Employees and managers of companies in India are also permitted to participate in their holding companies' ESOPs outside of India, either under a cashless scheme or where a price variable is involved. However, if such an option were to be exercised by an employee or director in India, much tax-related compliance are relevant and should be carefully considered prior to the option of participation.


An employee stock ownership plan is an employee benefit plan eligible under the Internal Revenue Code of 1986, for tax-favored treatment. If it complies with different participation, vesting, delivery, and other rules defined by the Code, a plan is eligible. An ESOP mainly invests in the stock of the company that funds the ESOP, defined as a form of deferred compensation plan. An ESOP must also comply with the Employee Retirement Income Protection Act of 1974, (ERISA), certain reporting and disclosure provisions and fiduciary duty laws. The Code and ERISA specifications jointly protect the rights of employees.

An ESOP is a defined contribution plan, means the contribution of the employer is defined and the profit of the employee is variable. An sufficient number of shares of company stock or cash contributions over the duration of the employee's employment is credited to each participating employee's account. Upon retirement, death, disability or other termination of employment, the employee's account shall be allocated to the former employee in shares of stock, cash or a combination of both, with the sum determined by adding the actual fair market value to the number of shares of the company's stock assigned to the former employee's account. Therefore the profit of an employee is not specified but depends on the value of the stock.

The leading case of Assistant Commissioner of Income Tax vs. Ruchika Chemicals Pvt. Ltd laid down that the crux of the claim advanced on behalf of the assessee is that he should have complied with the orders of the SEBI and obey the instructions relating to the employee stock options plan.

In the landmark case of Principal Commissioner of Income Tax v. Veeran Pvt. Ltd., the court ruled that majority of the shares had not been received from the settler of the market and the shares which had been received from the settler through the employee stock option plan had been held with him for a long period of time.

In two stages, ESOP is taxed. First Employees exercised the option- when ESOPs work, the exercise price minus the value of the security and the tax deducted at source is regarded as a requirement in the hands of the employee. The total sum of shares assigned to an employee, listed on any stock exchange in India, is the average market price at that date. If the shares are not listed, a valuation certificate shall be sought in respect of the same, which shall not be older than 180 days from that date.

Secondly, the employee eventually sells the shares purchased under ESOP. Under the head of Capital Gains, such transactions would be charged. Again, listed and unlisted shares are handled differently in which if kept for more than a year, listed shares become long-term, while the unlisted shares become long-term after 3 years. Long-term capital gains are fully exempted under Section 10(38) of the Income Tax Act, when trading on a stock exchange. Section 112A of the Income Tax Act, if long-term capital gains exceed Rs. 1 lakh, then with effect from 1 April 2018, the sum in such excess is taxable at a rate of 10 percent without indexation. If the securities are not sold on the stock market, the long-term capital gains would be measured after the initial price has been indexed, i.e. taxed at a flat rate of 20% plus surcharge and cessation of education.


It can be split into two groups when it comes to classifying the ESOPs, namely:

i.) Non-compensatory scheme

ii.) Compensatory scheme

i.) Non-Compensatory Scheme

Under this which no benefit/compensation is earned by the employees. The fundamental goal of such a strategy is either to diversify ownership to include employees or to increase the company's additional capital. In a non-compensatory scheme, the shares will be at market price at the date of exercise/investment in the future.

ii.) Compensatory scheme

The employees are paid/compensated in this group. In other words, the services provided by the workers are paid in part for the issuance of shares of a certain amount. These kinds of plans are used by businesses to inspire employees. Compensatory benefits are especially beneficial for fast-growing knowledge-based enterprises that typically do not pay employees large salaries.


Prepare the draft of Employee Stock Option Plan in accordance will section 62(1) of the Companies Act, 2013 and rules and Guidelines given concerning ESOPs in 1999.

With respect to ESOPs in India, there are no clear directions given by the Institute of Chartered Accountants of India (ICAI). The guiding principles are the guidelines released by the Securities and Exchange Board of India (SEBI) in the year 1999.

The legal standards and accounting procedures to be practised under ESOPs are regulated by these guidelines. Although an ICAI Guidance Note was issued in 2003 in conjunction with the ICAI Professional Ethics, the provisions of the Guidance Note are not necessary for compliance, and such a Note merely offers guidance to the preparers and auditors of the financial statement on any accounting matter.

In the years 2002 and 2003, the SEBI Guidelines were amended and now the amended Guidelines provide for a comprehensive disclosure of stock option compensation expenses determined by using the fair value method and also the effect on basic and diluted EPS of non-recognition of fair value compensation costs.


Recently, in 2013, SEBI narrowed the scope of the application of ESOPs by restricting the purchase of its own shares from the secondary market by listed companies.

The concern was that, through corrupt practises, the framing and administration of such programmes contributed to inflation, deflation or volatility in the price of securities. Subsequently, A proposal was made to replace the ESOP Guidelines with a collection of regulations to ensure improved compliance capability, to provide a regulatory structure for all forms of employee benefit schemes, including company shares, to resolve the issues posed with regard to the composition of employee welfare trusts, disclosures, etc., and to enable secondary market transactions with adequate information. The proposal was approved at the SEBI Board meeting in June 2014 and, as a result, SEBI released a new regulation on ESOPs on 28 October 2014.


Employee stock option plan increases the productivity of workers since they offer them the ability to make further attempts to equitably divide the profit share in the company. As ESOPs have practically zero personnel costs and are also a fantastic recruitment tool, company owners who wish to fund their own organisation with a tax-deductible donation are most sought after. ESOPs can also be a very powerful forum where employees can reap pension benefits without giving up their company's stock options. While ESOPs can be useful for many companies, they are not that helpful for large businesses that are too valuable to purchase and very small businesses that are affected by low sales and less issues with employees. For businesses seeking liquidity and succession alternatives, it is simple to pitch the advantages of ESOPs. However for ESOPs, there are good reasons not to go. Employee stock ownership policies have complicated rules that require substantial monitoring. While it could be handled by outsourcing this role to external advisors and ESOP TPA (Third Party Administration) firms, the ESOP organisation needs some internal staff to support this programme.








vii.) Description and Purpose of an ESOP - Employee Stock Ownership Plan | The National Law Review (

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