What Is ESOP Employee Stock Ownership Plan Explained

What Is ESOP?
Employee Stock
Ownership Plan
Explained

Employee Stock Ownership Plans (ESOP) have become popular recently due
to the various benefits they provide the company and the employees. It is a
well-known fact that we tend to care about the things we own and providing
employee stock options in the company makes your employee feel a sense of
ownership in your company.
Hence, many companies have started providing ESOP to their employees in a
bid to retain talented employees to gather more interest in their work and the
overall company’s success. It helps in garnering long-term interest, thereby
reducing employee turnover.
It also provides them with an investment option and motivates them to work
harder. The company redistributes shares in addition to the employee
compensation package which employees receive, creating a win-win
environment.

What is ESOP (Employee
Stock Ownership Plan)?
How Does ESOP Work?
The Employment Stock Ownership Plan (ESOP)
provides employees with stock options as a part of
their benefits plan to help them stay invested in
their company and work towards improving
company performance and turnover. Additionally,
ESOP also provides them with added incentive to
stay longer with their organization, thereby
reducing employee turnover.
Since the ESOP scheme provides the staff with
stock options, they would be actively involved in
their work since it benefits them directly. On the
other hand, the company gains loyal staff who
would feel appreciated, since the company is
offering them stock options in return for their
services.
ESOPs are granted by employers to their
employees as a form of employee compensation to
ensure long-term loyalty and improved
productivity. Hence, the management,
administration, and the HR department consult
with each other to decide the number of shares to
be offered, their pricing, as well as the beneficiaries
of these stocks.
Once these factors are decided, the eligible
employees themselves are intimated about their
inclusion in the ESOP and a grant date is decided.
Once the ESOP is approved, they remain in a trust
fund for a specific duration, defined as a vesting
period. The employees are required to stay in the
company within this vesting period to avail the full
ownership interest of the stock.
At the end of the vesting period, the employees are
given the right to exercise their ESOPs. One
should note that the employees are required to buy
the shares after the vesting period expires for
owning them. They can even sell these shares for a
profit later.

What are the Associated
Costs?
How to Register an ESOP?
There are no ESOP up-front costs associated
with providing ESOP to the employees. The
company may even choose to hold the shares on
behalf of their employees in a trust, and later
hand them over to the staff member when they
leave the company.
Due to such a vesting date, the employee
becomes eligible to earn an increasing amount
of equities every year, until they remain in
service with their company. When the employee
leaves the company, the company can ‘buy back’
their shares from the staff member. Based on
company policies, the organization can pay a
lump sum amount for buying the stock back.
• Following are the steps to be following while
registering for an ESOP:
1. Create the ESOP Blueprint
Creating a blueprint of the Employee Stock
Ownership Plan outlining the exact ESOP rules
is essential for granting ESOP benefits to your
employees. This blueprint will outline which
employees are to be included under the ESOP,
under which conditions they become eligible for
ESOP and what happens when their
employment with the company is terminated.
2. Documentation and Approvals
Once the blueprint is created, it is proofread
thoroughly and documented to avoid any
loopholes. The blueprint is then shared with the
board of directors and other stakeholders in the
company for their approval. They may even
suggest some changes if required and the
modified document is once again sent for
approval.

3. Draft Director’s Resolutions
Every time a new option is granted to an employee, you should discuss it with
management perspective and your director for collecting their resolutions in writing,
which approves the grant of options to a specific staff member.
4. Share the Grant Letter
Once you receive the grant letter from the director, you can issue the ESOP
certificate to the employee. The grant letter lets the employee understand the tax
benefits of their Employee Stock Ownership Plan as well as the number of stocks
granted to them. It also provides them with proof of ownership of their stocks.
5. Update Register
The company should maintain a register of all stock options provided, the employee
to whom it was shared, grant date, expiry date (if any), exercise dates, etc.
Maintaining a record of these values helps the company keep a track of the shares
vested with their employees.

Tax Implications of ESOP
• ESOPs are covered various tax implications as follows:
➔ Exercise Tax
When the employee chooses to exercise their Employee Stock Ownership Plan and buy the share, they
are required to pay tax on the difference between the ‘exercise price’ and the ‘fair market value (FMV)’
or market value of the share at the time of exercise. This tax is calculated as per the employee’s
income tax slab rate. The fair market value or the market price of the shares are decided by various
factors.
➔ Capital Gains Tax
If the employee sells the ESOP shares, then capital gains tax is applicable. Hence, the employee will
have to pay the short-term capital gains taxes, depending on the holding period of the shares. If the
employee sells beyond a span of 12 months after the initial purchase, a 10% capital gain tax would be
applied over gains of ₹1 lakh. On the other hand, if the shares are sold within a year, the gains are
subjected to a tax rate of 15%.
➔ Dividend Tax
If the organization is paying dividends on the shares held by their staff member, it is taxable as per
the applicable tax rates. While the dividends are taxable, the employee is still able to reap the profits
of the company by holding the shares allocated to them.

• For Further Details Visit Our Blog On
• URL:
https://www.pockethrms.com/blog/wha
t-is-esop/

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