Articles

Implementation of Employee Stock Option Scheme by a Private Company and Tax Implications

By March 31, 2020 May 1st, 2020 No Comments
IMPLEMENTATION OF EMPLOYEE STOCK OPTION SCHEME BY A PRIVATE COMPANY AND TAX IMPLICATIONS

IMPLEMENTATION OF EMPLOYEE STOCK OPTION SCHEME BY A PRIVATE COMPANY AND TAX IMPLICATIONS

A. APPLICABLE SECTION OF COMPANIES ACT:

 The procedure as laid down in Section 62 (1) (b) of the Companies Act, 2013 read with Rule 12 of the Companies (Share Capital and Debenture) Rules, 2014 is to be followed.

 B. APPROVAL REQUIRED UNDER COMPANIES ACT, 2013 BY PRIVATE COMPANY:

Ordinary Resolution in terms of Notification dated June 05, 2015. Further, the approval of shareholders by way of a separate resolution shall be required to be obtained by the company in case of:

(a)  grant of an option to employees of the subsidiary or holding company; or

(b) grant of an option to identified employees, during any one year, equal to or exceeding one percent of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of an option.

The term “Employee” shall mean:

  • a permanent employee of the company who has been working in India or outside India; or
  • a director of the company, whether a whole-time director or not but excluding an independent director; or
  • an employee as defined in clauses (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company 1[Omitted] but does not include-
  • (i) an employee who is a promoter or a person belonging to the promoter group; or
  • (ii) a director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than ten percent of the outstanding equity shares of the company.

Provided that in case of a start-up company, as defined in the notification dated 19th February 2019 issued by the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry Government of India, Government of India, the conditions mentioned in sub-clause (i) and (ii) shall not apply up to ten years from the date of its incorporation or registration.

C. VESTING DATE:

The dates on which the employee becomes entitled to exercise the right to acquire the shares is called "vesting date". Under the ESOP scheme, the stock option is free when it is given to an employee. The terms and conditions on which employee can exercise his options are spelt in the ESOP scheme and the grant letter. The option may get vested in the employee in the next future date/s as mentioned in the grant letter. There shall be a minimum period of one year between the grant of options and vesting of the option.

 D. TRANSFERABILITY OF OPTIONS:

 The option granted to employees shall not be transferable to any other person and no person other than the employees to whom the option is granted shall be entitled to exercise the option. However, 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.

E. WHAT CAN BE THE EXERCISE PRICE OF OPTIONS?

Exercise of an option is the process by which a vested option is converted into shares by payment of the exercise price. The Companies Act lays down that the companies granting an option to its employees pursuant to the Employees Stock Option Scheme will have the freedom to determine the exercise price in conformity with the applicable accounting policies. However, ESOPs cannot be given free of cost to the employees. They have to at least pay the nominal value, which is the face value of the shares. Further, the exercise price may differ from employee to employee. For example, if an employee of a company has joined right from the incorporation of the company and has given his sweat and time for the growth of the company, then he shall be paying the face value of shares as the exercise price. Further, as the company grows the employees joining subsequently shall pay a higher exercise price depending on the growth and valuation of the company. Further, if a company so wishes, it can impose a lock-in on the shares issued pursuant to the exercise of the options.

 F. WHAT IS THE IMPACT ON THE P/L OF THE COMPANY AT THE TIME OF GRANT OF OPTIONS?

Under Indian GAAP, the Company shall obtain a valuation of the options at the time of grant of options to the employee for the purpose of determining the amount to be charged in the P/L of a company during the vesting period of options, so granted by the company to the employee. For companies to which IND AS is applicable, it may be noted that the accounting for ESOP is dealt in Ind AS 102 which lays down that the entire amount shall be accounted in the P/L of a company in the year of the grant itself.

 G. WHAT IS THE TAX INCIDENCE ON EMPLOYEES AT THE TIME OF EXERCISE OF OPTIONS?

Tax incidence on the employees is at the time of exercise of options i.e. when the employee exercises the option to buy the shares at the exercise price. As and when the options under the ESOPs are exercised, the difference between the fair market value of shares and the exercise price is treated as perquisite in the hand of the employee. In case the shares are not listed the fair market value of the shares shall be determined by obtaining a valuation certificate from the merchant banker and such a certificate of valuation of shares should not be older than 180 days from the date of exercise of the option.

H. WHAT ARE THE TAX IMPLICATIONS WHEN THE SHARES ACQUIRED UNDER ESOPS ARE DISPOSED OFF?

When the employee actually sells the shares, the incidence of sale will attract capital gains tax. The gains can be either long term or short term, depending on the period for which the employee has held the shares. The holding period requirement is different for listed shares as well as for unlisted shares. Listed shares shall become long term if held for more than one year. Unlisted shares are treated as a long term only when held for more than 24 months.

If the shares are not sold through the platform of the stock exchange, the long term capital gains shall be calculated after applying the indexation to the original cost of purchase. Indexed gains so calculated shall be taxed at a flat rate of 20% plus applicable surcharge and education cess. You have the option to pay tax @ 10% on capital gains without applying indexation benefits plus applicable surcharge and education cess. Such short-term capital gains are to be treated like any other income and added to other income and taxed at the slab rate applicable.

For the purpose of computing the capital gains the fair market value as on the date of exercise, is treated as the cost of acquisition and not the price actually paid by the employee.

Authors: Prashant Jain, Co-Founder & Partner; Anita Dugar, Senior Associate.

Disclaimer: The content of this article is intended to provide a general guide to the subject matter. For any queries, the authors can be reached at (i) prashant@samistilegal.in (ii) anitadugar@samistilegal.in.

Updated as on March 31, 2020.

Image generation credits: https://www.canva.com/templates/

Leave a Reply