Apr 22,2019 | 15 min read

All you need to know about Employee Stock Option Plan (ESOP) by Advocate Neeraj Dubey

Author: Advocate Neeraj Dubey and Associate Debasmita Patra

Employee Stock Ownership Plans is a qualified employee benefit plan under which the employees of a business are given a right to acquire a share or ownership interest of the company they are working for. An ESOP is provided to the employees by their employer either as a reward or as an exit strategy from business ownership. Such scheme grants employees with some rights to acquire the shares of the company for free or at a concessional rate, as compared to the market rate.

ESOPs, like stock options, are given to the employees by either borrowing funds or receiving contributions from the company that is ultimately used to buy shares in the business. Established by the owners of the company, the scheme allows employees full or partial ownership of the company where the latter enjoys numerous tax benefits. These plans act as compensation in some cases while in the others they ensure long term commitment on the employee’s part.

The stock option, under the ESOP scheme, is provided to an employee for free while he has to exercise his right as per the terms and conditions in the previous scheme. The right to exercise an ESOP is valid after a certain locking period. The employee can use the right to acquire share on a future date called vesting date. Grantor exercise price is one at which an employee can receive the share of the company where the price is generally fixed and is most often lower than the prevailing market price of the share.


The absence of any obligation attached to be option makes it non-mandatory for an employee to exercise the option. It upon the discretion of the employee to exercise the option or, in case the prevalent price of share being lower than the exercise price, or not to do so. There is a stipulated time within which the right to acquire share by an employee can be exercised. Once the option has been exercised, the employee has to pay for the share at the pre-determined price, thereby creating cash outflow. Liquidation is not possible if the shares are not listed on the stock exchange which results in the amount paid getting locked till the shares get listed or the promoter offers an exit option.


 ESOP is taxed in two stages. Firstly, when the option is being exercised by the employee. The exercise price, when ESOPs are functioned, minus the value of the security and the tax deducted at source, is treated as a prerequisite in the employees hand. The total amount of the shares, listed on any stock exchange in India, allotted to an employee is the average of the market price on the exercised date. If the shares are not listed, a valuation certificate regarding the same is sought after, that cannot be older than 180 days from the said date.


Secondly, when the shares acquired under ESOP are ultimately sold by the employee. Such sale will be taxed under the head of Capital Gains. Here again, listed and unlisted shares are treated differently wherein listed shares become long term if held more than a year whereas the unlisted ones become long term after 3 years. If the trading of share is done on a stock exchange, the long term capital gains are completely exempted under Section 10(38) of the Income Tax Act, under. Section 112A of the Income Tax Act (via Finance Act 2018), long term capital gains if exceeds Rs. 1 lakh, then the amount in such excess is taxable at a rate of 10 percent without indexation, with effect from 1st April 2018. In case the shares are not sold through a stock exchange the long term capital gains are calculated after the original price has been indexed, that is to be taxed at a flat rate of 20 percent plus surcharge and education cess.

Just like any other investment decision, the employees entitled to stock options should take the capital gains’ impact and implications into account before giving a final call. By way of ESOP, an employee is benefited with a stock reward, ultimate control of the business and low-cost benefit. ESOP is a powerful tool for attracting talented employees as it does not cost employees anything to participate.

Though ESOPs can be beneficial for many businesses, they are not that useful for large companies that are too valuable to buy and very small companies that are stricken with low revenue and fewer employee troubles.


As ESOPs have virtually zero cost for the employees and are also a great recruiting tool, they are most sought after by business owners who want to finance their own organization through a tax-deductible contribution. ESOPs can also be a very effective platform where the employees can enjoy retirement benefits without giving up stock options in their company.

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Neeraj Dubey

Neeraj advises start-ups in structuring, funding & compliance requirements, choosing appropriate legal structures, their registration and licensing, conducting legal audits before funding/acquisition, drafting & reviewing contracts/agreements, advisory on employment laws, IP & data protection, dispute resolution & taxation.


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