Employee Stock Option Plan(Esop)

Gaurav Shanker    |   

Employee Stock Option[1] (Stock Options) means rights/options given to employees, directors or officers of the company for buying shares of the company at a future date at a pre-determined price.

The employee has the option to set aside his option and decide whether to exercise it or not depending on the market price of the share.

Employee Stock Option Plan means a plan recommended by the board in a meeting by passing a resolution to that effect. The board lays down certain procedures as regards grant of options, vesting period, determination of exercise price,eligibility of employees to which option is to be granted etc.

Some important definitions covered under Employee Stock Option Plan (ESOP):

  • Meaning of “option”: An option refers to a right/choice but not an obligation to purchase the shares of the company on the fulfilment of certain conditions mentioned in ESOP plan at a pre-determined price at the time of grant of options.
  • Meaning of “grant”: The eligibility of a particular employee for grant of stock options based on his performance and role.
  • Meaning of “vesting period”: It refers to the period on the completion of which the stock option can be exercised.
  • Meaning of “exercise price” and “exercise period”: Exercise price is the price which the employee has to pay upon conversion of the stock options into equity shares of the company. The exercise period is the period within which the applicable employee can decide to exercise his stock options.
  • Meaning of “effective date of exercise”: The effective date of exercise the date on which the company allot the shares to the concerned employee.
  • Meaning of “shares” , share means equity shares and securities convertible into equity shares and shall also include American Depository Receipts (ADRs), Global Depository Receipts(GDRs) or other depository receipts representing underlying equity shares or securities convertible into equity shares.

Why do companies offer ESOP’s?

ESOP’s are the best and most frequently used tools to retain top notch employees in a company. It also has various other advantages:

  • It develops a sense of ownership amongst the employees and can get them highly inspired and focused for their jobs.
  • It is a non cash compensation tool to compete for the best human resources at affordable consideration.
  • It helps in alignment of managers’ interests with that of the owners.

Eligibility of employees to participate in ESOP:

As per the Company Rules, a permanent employee working in Indian or outside India, a whole time or part-time director of a company and an employee of a holding company, subsidiary company or an associate company is entitled to participate in the ESOP plan. However, the organizations have different eligibility criteria set for their employees who wish to participate in this plan. Following is the category of certain employees who are not entitled to participate in the ESOP plan.

  • An employee who is a promoter or belongs to the promoter group shall not be eligible to participate in the ESOP.
  • A director who either himself or through his relative or through any other body corporate, directly or indirectly, holds more than 10% of the outstanding equity shares of the company shall not be eligible for ESOP.
  • An Independent Director shall not be eligible for the stock options.

 Issue of ESOP’s in public and private companies:

The provisions relating to the issue of ESOP’s is common for all unlisted companies irrespective of the status being Public or Private Limited Company.

In case of unlisted companies the appraisal process is to be adopted for determining the eligibility and class of the employees for participation in ESOP scheme.

Procedural Requirements:

  • Approval by the members of the company by way of special resolution is required;
  • Approval of shareholders by way of separate resolution in the general meeting for grant of ESOP’s to employees of the subsidiary and holding company or in case of grant of ESOP’s to identified employees in any one year equal to or exceeding 1% of the issued capital at the time of grant of option ;
  • There shall be an explanatory statement disclosing the number of ESOP’s to be granted, eligibility of employees, vesting requirements, vesting period, exercise price, method adopted by the company to value its options whether at fair value or intrinsic value; etc.
  • The employees shall not have the right to receive dividends or to vote or enjoy in any manner the benefits of a shareholder in respect of option granted to them, till shares are issued on exercise of option.
  • The company shall have the freedom to specify the lock in period for the shares issued pursuant to exercise of option.
  • The amount, if any, payable by the employees, at the time of grant of option (a) may be forfeited by the company if the option is not exercised by the employees within the exercise period; or (b) the amount may be refunded to the employees if the options are not vested due to non fulfilment of conditions relating to vesting of option as per the Employees Stock Option Scheme
  • In the event of the death of an employee while in employment, all the options granted to him till such date shall vest in the legal heirs or nominees of the deceased employee. In case, where the employee suffers a permanent incapacity while in employment, all the options granted to him as on the date of permanent incapacitation, shall vest in him on that day.
  • The employee can exercise the options granted to him which are vested within the period specified in this behalf, subject to the terms and conditions under the scheme granting such options as approved by the Board in the event of termination or resignation of employee. However, in case where no option is granted, it shall expire on his termination or resignation from the company.

The companies granting options usually adopt two methods of valuation of exercise price (a) Intrinsic value method and (b) Fair value method. The companies have the freedom to determine the exercise price subject to conforming to the accounting policies, provided that in case the company calculates the employee compensation cost using the intrinsic value of the stock options, the difference between the employee compensation cost so computed and the employee compensation cost that shall have been recognized if it had used the fair value of the options, shall be disclosed in the directors report and also the impact of this difference on profits and on earning per share of the company shall also be disclosed in the directors’ report.

Other Procedural Requirements include:

  • Minimum vesting period of 1 year;
  • Non-transferability of the ESOP’s;
  • The option granted to the employees shall not be pledged, hypothecated, mortgaged or otherwise encumbered or alienated in any other manner
  • Variation in the terms of ESOP to be carried by way of member’s approval by passing a special resolution to that effect. The notice for passing special resolution for variation of terms of Employees Stock Option Scheme shall disclose full information of the variation, the rationale therefore, and the details of the employees who are beneficiaries of such variation;
  • Maintenance of an ESOP register in Form SH-6, entering therein the particulars of option granted under the scheme. The register of ESOP shall be maintained at the registered office of the company and such other places as the board may decide. Also, the entries are to be authenticated by a company secretary or by such other person which the board may authorise.[2]

 Procedure for issue of ESOP’s in case of Listed Companies

The Securities and Exchange Board (SEBI) lays down certain guidelines for determining eligibility as to employees who can participate in Employee Stock Option Plan.:

  • Where an employee is a director nominated by an institution as its representative on the board of directors of the company, the contract/agreement entered into by the institution for nominating its employee as the director of the company and the nominated employee shall specify whether the options so granted to the employee under Employee Stock Option scheme can be accepted under its capacity as a director. An option if granted shall not be renounced in the favour of nominating institution.
  • The contract/agreement so entered into between the institution nominating its employee as the director and the director so nominated, shall also specify the conditions subject to which fees,commissions, other incentives etc. can be accepted by the director from the company
  • The institution nominating an employee as its director shall file a copy of the agreement with the said company which in turn file the copy with all the stock exchanges on which its shares are listed.
  • The director so appointed shall furnish a copy of the contract at the first board meeting of the company attended by him after his nomination.


In case of listed companies the ESOP’s are offered to the employees by adhering to the provisions laid down in SEBI (Share Based Employee Benefits) Regulation, 2014.The procedures are listed herein under:

  • An advance notice of the board meeting is to be given at least two working days prior;
  • The board meeting to be held for approving the ESOS and calling and approving the notice of annual general meeting /extraordinary general Meeting by passing special resolution.

In case where a company having a share capital, proposes to increase it by issuing further shares, then such shares are to be offered to employees under ESOS in accordance with SEBI (Share Based Employee Benefit) guidelines subject to passing of special resolution in general meeting.

  • An advance notice of the general meeting at least two working days prior before to the stock exchanges where securities are listed is to given.
  • Holding of general meeting and passing required special resolution.
  • Outcome of meeting is to be notified within 30 minutes of its conclusion to relevant stock exchanges.
  • Filing e-form MGT-14 within 30 days of passing the special resolution with registrar of companies.
  • The company shall appoint a registered merchant banker for the implementation of schemes covered by these regulations.
  • The company shall constitute a Nomination & Remuneration committee for granting of options to its employees. The ESOS shall contain the details of the manner in which the scheme will be implemented and operated and no ESOS shall be offered unless the disclosures, as specified by SEBI in this regard, are made by the company to the prospective option grantees.
  • The company to intimate the stock exchanges regarding the grant made to its employees within 30 minutes of conclusion of meeting.
  • The company to hold board meeting for allotment of shares and intimate the stock exchange about such allotment not later than 24hrs of conclusion of meeting.
  • The company to file a return of allotment in form PAS 3 with the registrar of companies within 30 days from the date of allotment. In case of allotment to NRI form - FCGPR is to be filed within 30 days with the Reserve Bank of India.
  • The company to pay a stamp duty to the government within 30 days of issue of shares. The stamp duty can be paid online by logging into http://www.shcilestamp.com/estamp_share_issuance.html. The company to upload all essential documents after which the department will generate a challan against all documents submitted online .The payment is required to be made within 5-6 business days after which a copy of challan is to be submitted with Revenue Department. On verifying, the department will issue a certificate, certifying payment of stamp duty.

         Tax implications on ESOPs.

  • When the options are given by the company, there is no tax. When the options get vested, there is no tax.
  • When the employee exercises his option of buying the shares, the difference between the market value and exercise value is treated as perquisite and is taxable as per the tax bracket that the employee falls[3] in. The employer deducts TDS on this perquisite. This amount is shown in the employee’s Form 16 and included as part of total income from salary in the tax return.
  • When the employee sells the shares, the profit (i.e the difference between the sale price and the fair market value of the shares on the exercise date) is treated as capital gains. If the shares sold within one year and STT (Security Transaction Tax) has been paid, 15.45% capital gains  tax has to be paid just like in the usual purchase and sale of shares. However, in case of unlisted companies if shares are sold within 1 year the rate is 30%. If the shares are sold after 1 year and Security Transaction Tax is paid (as per the recent circular of the IT Department it is not a mandate) there is no tax as it is considered as long-term case of unlisted companies if shares are sold after 1 year long term capital gains are taxed at 10%(without indexation benefit) and at 20% (with indexation bgain and is exempted under the Income Tax Act 1961[4]. However, in enefit).

Taxability in the hands of the employer:

The perquisite value that is added to the salary income of the employee, imposes an obligation on the part of the employer to withhold tax at source [5]and the same will reflect in Form 16 of the employee. Also, the discount at which the shares are allowed to the employees (fair market value of the shares on the exercise date less issue price of the shares) shall be allowed a deductible expense under Income Tax Act 1961[6].




[1]Section 2(37) of the Companies Act 2013

[2] Rule 12(1), Rule 12(2), Rule 12(4) of Companies (Share Capital and Debenture, Rules 2014) read with Section 62(1) (b) of Companies Act 2013.

[3]  Section 17(2) of the Income Tax Act 1961.

[4] Section 10(38) of the Income Tax Act 1961.

[5] Under Section 192 of the Income Tax Act 1961.

[6] Section 37(1) of the Income Tax Act 1961.