DIFFERENT TERMS USED IN AN ESOP Employee Stock Option Plan (ESOP), is a plan through which a company awards Stock

Options to the employees based on their performance. Under an ESOP, the employees have right to buy the shares of the company on a predetermined date at a predetermined price. The objective of ESOP is to motivate the employees to perform better and improve shareholders' value. Apart from giving financial gains to the employees, ESOP also creates a sense of belonging and ownership amongst the employees. A stock option granted to specified employees of a company: Grant date: The date on which the company grants an option to its employee. Option price: The price at which such shares in a scheme are offered. It is also known as the strike price or grant price. Normally such option price would be below the market value/ fair value of the shares on the date of grant. Vesting period: Vesting has two components vesting percentage and vesting period. Vesting percentage refers to that portion of total options granted, which you will be eligible to exercise. Vesting period is the period on the completion of which the said portion can be exercised.

For Example: Mr Deepak has been given a stock option from his company for a vesting period of 3 years in the year 2 February 2012. This means that vesting date is 2 February 2015. The price at which 500 shares were offered to Mr Deepak was Rs 250 each. This price is the vesting price. This means that on 2 February, 2015 he can exercise his right to purchase the share, depending on the conditions. Lets say, the price of share on 2nd Feb, 2015 is 650, this will result in a gain of Rs 400 each, which garners a profit of Rs 2,00,000 to the employee, if he exercises the option after 3 years.

Exercise period and Exercise date: The employees would be given a time period, called exercise period, within which they are required to exercise the option. The date on which employees exercise this option is called exercise Exercise period is the period within which you can decide to exercise your options. This period starts from the date of vesting. Lapse of options Options lose their validity in certain circumstances i.e. expiry of the exercise period, separation, abandonment etc. These options then cannot be converted into shares and lose their value. Such options are said to be lapsed.

SEBI GUIDELINES
1.

Issue at discount Issue of stock options at a discount to the market price would be regarded as another form of employee compensation and would be treated as such in the financial statements of the company regardless the quantum of discount on the exercise price of the options.

2.

Approval: The issue of ESOPs is subject to the approval by the shareholders through a special resolution.

3.

Minimum period and Maximum period A minimum period of one year between grant of options and its vesting has been subscribed.. A Maximum period of eight year between grant of options and its vesting has been subscribed. Employee stock option must be exercised within the period of five years

4.

Superintendence The operation of the ESOP Scheme would have to be under the superintendence and direction of a Compensation Committee of the Board of Directors in which there would be a majority of independent directors.

5.

Eligibility ESOP scheme is open to all permanent employees and to the directors of the company but not promoters and shareholders. The scheme would be applicable to the employees of the subsidiary or a holding company with the express approval of the shareholders.

6.

Director's report The Director's report shall make a disclosure of the following:

Total number of shares as approved by the shareholders The pricing formula adopted Details as to options granted, options vested, options exercised and options forfeited, extinguishments or modification of options, money realized by exercise of options, total number of options in force, employee-wise details of options granted to senior managerial personnel and to any other employee who receive a grant in any one year of options amounting to 5 percent or more of options granted during that year

Fully, diluted EPS computed in accordance with the AS-20

RULES AND REGULATIONS Companies Act Issue of stock options requires approval of shareholders by way of a special resolution as per section 81(1 a). This is not applicable for private companies who can issue stock options without shareholder approval but approval by the board of directors.

Income Tax Issues For employees: Till recently, the difference between the cost of the share to the employees and market value on the date on which an employee got the share would be taxed as perquisite in addition to capital gains tax payable by the employee on sale of those shares. However with the recent announcement by the Finance Minister the perquisite tax has been removed. Tax is now payable only at time of sale of shares as capital gains.Since perquisite tax has been removed employers are not liable for tax deduction at source, thus removing administrative inconvenience. For the company: As per SEBI guidelines listed companies have to account for ESOP by treating the same as an expense. As yet there is no clarity whether this expense will be allowed as deductible expense by the Income Tax authorities.

Taxation Of ESOPs In India Until 1995, there was no provision to tax ESOP. But, in that year, Income Tax Authorities clarified with the help of a circular that these options which make the shares of company available to employees at lower than market price will attract taxes. First and foremost thing is the discretion of the employee. Exercising of option or its rejection is totally dependent on the employee. ESOP benefits form a part of employee salary and are taxable as a perquisite. The calculation is based on the Market Value of share at the date of exercising of option and the vested price. Ordinary residents are liable to pay these taxes on the basis of global income. For Companies Listed In India: For all the companies listed in India, 15 percent of the tax is charged under Short Term Capital Gains. Long Term Capital Gain Tax (LTCG) doesnt arise in this case. For Companies Listed Outside India: For the companies those are not listed in India but listed in other exchanges across the globe, the Short Term Capital Gain will be added as a part of salary and tax is charged based on the salary slabs. LTCG charged is 20 percent along with indexation. Example: Employer has given the option of allotment of total 400 shares, for the next 4 years, for all eligible employees. The vesting price is Rs 100 and starting date of allotment is 1 July 2010. Mr Raj, one of the company employees is allotted 100 shares on 1 July 2010, at the vesting date the price of share is Rs 500. He sells these shares at Rs 1500 on 1 December 2011. TAX At the time of Allotment: STCG will be (500-100) * 100 * 20% = Rs 8000 (Considering Mr Raj is in 20 percent bracket). TAX At the time of Sale: (1500-500)*100*15% = Rs 15000 There have been various changes in the taxation of ESOPs in the past 20 years. The Government finally seems to have found a logical way of taxing ESOPs. The manner of computation of Tax of ESOPs in the hands of the employee has been explained hereunder:-

At the time of giving ESOPs: The benefits arising on ESOPs are taxed as Perquisites in the hands of the employee and form a part of the employees salary income. The employer is also required to deduct TDS in respect of such perquisite. The perquisite value is computed as the difference between the fair market value of the share and the Exercise price. At the time of sale of such ESOPs by the employee: The gains arising on the sale of ESOPs are considered to be Capital Gains; Capital Gains Tax is levied on the such gains and tax is liable to be paid in the year in which such ESOPs are sold. The Capital Gain is computed as the difference between the sale price and the price at which it was awarded by the Employer. The Capital Gains treatment further depends on the holding period of the ESOPs i.e. if the shares are held for less than 12 months Short Term Capital Gains Tax@ 15% is levied and if the shares are held for more than 12 months- Long Term Capital Gains Tax is levied (this is currently NIL). Thus, if such ESOPs are held by the employee for more than 12 months, the gains arising on the sale of such ESOPs is effectively exempt from Tax.