ESOPs OR SWEAT EQUITY

ESOPs or SWEAT EQUITY is the stuff that has made crorepatis of even car-drivers in
Company(s) like Infosys. These are relatively new in India but gradually becoming the
most favoured portion of remuneration in private Company (s).

WHAT ARE ESOPs?

ESOPs or "Employees Stock Options Plans" is the generic term for a basket of
instruments and incentive schemes that find favour with the new upward mobile salary
class and which are used to motivate, reward, remunerate and hold on to achievers.

ESOPs are generally granted in the form of directly allotted shares, debentures or
warrants, stock options etc. These ESOPs can have numerous variations/ alternative
options. The characteristic facet of these ESOPs is that the compensation gets linked
with the increase in the price of the shares of the Employer Company or rather the net
worth of Company.

VARIETY OF ESOPs

First variety of ESOPs is the scheme under which the employee is directly allotted shares
by the Company either at market price or at a concessional price. Source of purchase
may be own funds of the employee or loan(s) from the Company / Banks / Financial
Institutions.

Second Variety is when the employee has the 'option' to acquire the shares, debentures
or warrants of the Company at a price that may be the market price or lower than that.
After that there is a waiting period or Vesting Period when the employee has to wait to
exercise his option. After this is the 'Exercise-Period' during which the employee can
exercise the option to seek allotment of shares.

There may also be a 'Lock-in Period' during which the employee can not sell these
shares.

Third Variety may be 'Stock Appreciation Rights'. A specified number of shares are
notionally allotted to him at a certain price. At the end of a specified period, the price of
the shares is noted and if the price has increased then the difference is paid to him by
the Company.

Another Variety may be 'staggered options' available to the employee over a period of
time.

WHAT IS A STOCK OPTION?

It is a right, but not compulsion. The option-holder may or may not acquire the shares of
the Company during a Specified period at pre-determined price, irrespective of the
market-price at the time of giving the Stock option by the Company or at the time of
exercise of the option by the employee.

There are so many factors to determine the employee's decision. The employee
ultimately may not exercise his option.
WHAT IS SWEAT EQUITY?

'Sweat Equity' means equity shares issued by the company to employees or directors at
a discount or for consideration other than cash for making available know how in the
nature of intellectual property rights or value additions, by whatever name called.

WHO CAN ISSUE SWEAT EQUITY?

All Company(s), whether private, public, listed or not-listed can issue Sweat Equity
Shares,

WHAT IS THE DIFFERENCE BETWEEN 'SWEAT EQUITY' AND 'ESOPs?

There may be no difference as the objective of both is to remunerate the employee.

Sweat Equity is only for issue-of shares, debentures or warrants at a discount or
even nil consideration. ESOPs are incentive scheme(s) to motivate and retain productive
employees.

CAN 'SWEAT EQUITY' BE ISSUED FOR FREE?

The Law has not set any limit on the rate of discontent for issue of shares to employees.

WOULD THE BENEFIT TO THE EMPLOYEE ON ACCOUNT OF FREE OR

CONCESSIONAL ALLOTMENT OR SHARES, DEBENTURES OR WARRANTS BE NOT
TAXED AS PERQUISITES?

Yes and no, both! For A.Y. 2000-01, the difference between the market value and the
cost of acquisition of such shares, debentures or warrants was taxable as perquisites.
However, for A.Y.2001-02 and subsequent year(s), the Law stands modified and such
benefit(s) are not to be taxed as perquisites. Mere grant of stock options or even
exercise of such stock options whereby shares are in fact allotted does not attract tax as
perquisite(s). They are to be taxed only once when sold, as capital gains.

BUT WHAT SHALL BE THE COST OF THE SHARES IF THE TAX HAD BEEN LEVIED
AS PERQUISITE AT THE TIME OF EXERCISE OF OPTION?

In case where tax has been levied as perquisite at the time of the exercise of the option
by the employees, its fair market value at the time of exercise of option shall be the cost
of the share for working out the capital gain. This amendment is w.e.f. 1.4.01 and,
applies in relation to the A.Y. 2001-2002 and subsequent years.

DOES IT MEAN THAT TRANSFER OF CAPITAL ASSETS RECEIVED AS ESOPs or

SWEAT EQUITY WOULD NOT ATTRACT CAPITAL GAINS TAX?

No. Now w.e.f. 1.4.2001 i.e. for A.Y. 2001-02 and subsequent year(s), even when such
share(s), debenture(s) or warrant(s) (received as ESOPs/Sweat Equity) are transferred
under a gift or an irrevocable trust, the transaction will be a taxable transfer. The
transfer consideration will be the market value of such assets minus the cost paid by the
employee, if any.
AT WHAT RATE IS THE LONG TERM CAPITAL GAINS IN RESPECT
TO GDRs ISSUED TO EMPLOYEES UNDER ESOPQ TAXABLE?

On Income by way of dividends or long term capital gains Global Depository Receipts
(GDRs) of an Indian company purchased by a resident employee of such company
engaged in information technology software and/or services, as per a notified ESOP, is
taxable @ 10% u/s 115 ACA.

DO THESE PROVISIONS EXTEND TO SUBSIDIARY COMPANIES, OTHER

KNOWLEDGE BASED INDUSTRIES?

Yes. With effect from 1.4.02, i.e, in relation to the A.Y. 2002-2003 and subsequent
years, this concessional rate of taxation now extends to income in respect of GDRs
purchased by employees of companies engaged in other knowledge based sectors also,
viz., entertainment service Pharmaceuticals, bio-technology industry or service as may
be notified. The concessional rate of taxation also applies to income from the GDRs
purchased by employees of subsidiary companies, whether domestic or foreign, of the
above companies.

WHAT IS THE POSITION OF TDS IN THE YEAR SUCH ESOPs OR SWEAT EQUITY
ARE GIVEN/ALLOTTED BY THE COMPANY?

When w.e.f 1.4.01 the Income Tax Act, 1961 does not consider concessional allotment of
share(s), debenture(s) or warrant(s) be treated as perquisites so the question of
deducting TDS is extraneous for A.Y, 2001-02 and subsequent year(s).