Offered Esops and caught in two minds? Here’s all you need to know

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Retaining talented employees and keeping them motivated is a challenging task for any organisation. A very common method through which companies incentivise employees is Employee Stock Options or Esops, which give employees the option of buying a certain number of shares of the company at a pre-decided price.

Data shows that at least 209 companies in India have announced Esops in FY21 despite the ongoing uncertainty due to Covid-19 pandemic. Private sector lender ICICI Bank on February 4 informed bourses that it has allotted 2,234,362 equity shares in the employee stock options scheme. Likewise, HDFC Life Insurance said it has allotted 2,25,002 equity shares.

Explaining the concept of Esops, TV Mohandas Pai, former Infosys CFO and CHRO and chairman, Manipal Global Education, said it helps in retaining good employees. He further explained that aligning an employee interest with a company’s vision is one of the major problems faced by India Inc.

“Therefore, the best alignment for a listed company or a company that will be listed is to make sure that its employees get some stock options. There is a direct link between the performance and the reward,” he added.

In India, information technology firms started the practice of offering Esops. Later, companies from various sectors embraced this trend. Matrimony.com, Brigade Enterprises, Magma Fincorp, Hero MotoCorp, SIS, Mphasis and Axis Bank were among the companies players who allotted shares to eligible employees in February so far.

Should an employee go for Esops?

ESOPs usually have a vesting period during which they cannot be exercised. In general, the grant price is determined by averaging the stock’s market price for a specific period.

“Decision to opt Esops depends on the difference between the exercise price and the market price of the stock. One should definitely go for it if there is a difference between the market price and the exercise price. If the difference is small but positive, you can choose to exercise and exit the stock immediately whenever you want to take some profits out of the ESOPs. If the exercise price is higher than the stock price then one should not exercise,” said Anil Rego, founder and CEO, Right Horizons.

Taxation

According to market experts, there are two stages of taxation of Esops. Let us see how they work:

On exercise: The difference between the exercise price and the fair market value is added to income and taxed as a prerequisite.

On sale: The difference between fair market value and sale price is taxed as capital gains. Capital gains are taxed as follows:

For Indian listed company shares: If held for a period of 12 months or less after exercise, this is treated as short-term capital gains, and taxed at 15%. After 12 months, the gains are called long term capital gains, and gains over one lakh are taxed at 10%.

For unlisted company shares, ESOPs held for over 24 months are treated as long-term capital gains which are taxed at 20% with indexation; otherwise short-term capital gains are added to income.

Furthermore, if you own shares across borders, the taxation is the same as unlisted company shares.

Pros and cons

Explaining the pros and cons, Rego said Esops are a great value creator. They have helped people build non-linear assets, not normally possible through salary income. It has also helped people to meet their family’s financial goals significantly.

On the other hand, he added that one needs to pay and exercise one’s options.

“There have been cases where people have taken a loan to exercise the Esop and the price fell. The loan then became a burden for the employee. Summary, is that if you can use Esops well, it is a great value creator. However, the issue is that most people cannot effectively leverage it because of lack of expertise in equity markets. They either sell the Esops to early or too late,” he said.