IT companies like “Infosys” started the trend of ESOP in the 1990s. The Employee Stock Ownership Plan (ESOP) generated substantial profits for the company and the employees. Later, banking and other financial service providers adopted ESOP for their employees and for shareholders. ESOP shares work holistically by allowing the employees to invest in their company and encourage high-quality work for mutual benefits.
In this guide, you will get to know about how to sell ESOP shares and their profit sharing.
ESOP Shares Meaning
Employee Stock Ownership Plan, as the name suggests, is a plan that offers an employee to own stocks in the company. The company issues stocks at discounted rates to eligible employees. To qualify for an ESOP, an employee must fulfill the criteria given by the Indian Revenue Service and also complete the vesting period as defined by the employer.
Read the full guide on – What are Esop Shares?
How are ESOP shares allocated?
The shares of an ESOP are allocated directly based on the annual wage given to the employee. Employees with higher compensation get a better percentage. There are other factors scrutinized before the allocation of ESOP shares. Certain issuers consider- the tenure an employee has served before allocating the ESOP shares.
Compensation definition as per Indian Revenue Service(IRC):
To prevent discrimination and establish a transparent compliance procedure, the IRC has defined- Compensation in the IRC Section 414(s). Compensation must satisfy the IRC safe harbor definition. ESOPs must clearly define the compensation definition they have used in the ESOP document. A company that fails to adhere to the IRC standards can affect the company’s reputation and have severe tax consequences.
How to calculate ESOP value?
Proper estimation of the ESOP value is necessary for accounting and tax requirements. There are two primary ways to calculate ESOP value:
-
Intrinsic Value Method:
“When the value of an investment is- calculated based on the cash flow, it is termed as Intrinsic value.”
In the intrinsic value method- the exercise and the current market price are used to calculate the ESOP value. The difference between the current market price and the exercise price is its intrinsic value. When the exercise price is higher than the current market price, employees do not receive any profit.
-
Fair Value Method:
The fair value method uses the option-pricing model to calculate the ESOP value of the stocks. In this method, certain variables are used to estimate the theoretical value of the stock under consideration.
Because the fair value method considers several factors like volatility, Interest rate, dividend, etc., it better estimates the ESOP value.
Common Fair Value Methods used to calculate ESOP value:
- Black Scholes Method
- Binomial Method
- Monte Carlo Method
How to sell ESOP shares?
An ESOP lock-in period prevents employees from instantly selling their shares. If an employee wishes to profit from an employee stock option plan, they must sell the shares when the market value of the ESOP is higher than the buying price.
The difference between the Fair Market Value of the company at the time of buying and the Fair Market Value at the time of selling is the capital gain of the employee. After-tax deductions imposed by the Indian Revenue Service(IRC), the ESOP shares receive their profit incurred.
Buy or Sell ESOP Shares on WWIPL.
Which companies are offering ESOP shares in India?
- Flipkart
- Larsen & Toubro
- UpGrad
- Razorpay
- Unacademy
- Zerodha
- Swiggy
- Paytm
- Nykaa
- OYO
- Amul
- and many more…
ESOP vs Shares
| ESOP | Shares |
| Employee Stock Ownership Plans give the employee the right to purchase the shares at prices provided by the employers. | Employees or directors of the company receive shares as a token of appreciation or for- the provision of intellectual property rights. |
| It is defined under Section 2(37) of the Companies Act, 2013 | It is defined under Section 2(88) of the Companies Act, 2013 |
| A predetermined rate of ESOPs is offered to employees as an option, which they can accept or reject. These are given to only those employees who choose to receive them. | Various forms of equity shares are provided directly to employees, such as a discount or some other type of non-cash consideration. |
ESOP vs. Profit Sharing
While ESOP has been in talks recently, profit-sharing plans have been used even before the ESOP was initiated. ESOP is also a form of a profit-sharing plan. However, certain factors help us differentiate between the two.
In profit-sharing plans, cash is directly contributed to the company. Because of this, there are no huge benefits for the organization and the promoters. To improve upon this, ESOP goes one step further and uses the cash provided by the employee to buy the company’s stocks and generate profit gains for the company and themselves in the near future.
Tax implication on buying/selling of ESOP shares:
Upon allotment of shares on the exercise date, the difference between fair market value and the amount an employee paid for the exercise is calculated and taxed. This tax value is nothing but the prerequisite value at the exercise stage and is taxed in the year of allotment of the shares. Later, when the employee sells the shares under ESOP, tax is levied on the amount of profit he has gained from the transaction. Depending on the holding period, this gain or profit is called “Capital Gain” and is categorized into “Short-term gain” and “Long-term gain”.
| Holding period | Tax Rate |
| Short-term capital gain/loss
(Two years or below) |
Tax as per the income slab rates applicable |
| Long-term capital gain/loss
(Above two years) |
20% with Indexation Benefit |
Taxation on IPO/Pre-IPO Shares (How to Sell ESOP Shares Guide)
Several exceptions apply to the rule that STT must be paid at the time of purchase, such as if shares were acquired through an IPO, were unlisted, or no STT was applicable at the time of purchase (STT came into effect on 1 October 2004). As a result, STT must be paid on the sale of such shares after they are listed on any recognized stock exchange. For shares held for 12 months, the following tax treatment would apply:
| Long Term Capital Gain(LTCG) | Taxed at 10%
(Above INR 1 Lakh) |
| Short Term Capital Gain(STCG) | Taxed at 15% |
Loss on Sale of Unlisted shares:
- Short Term Capital Loss(STCL) can be carried forward for up to eight years and adjusted against STCG and LTCG.
- Long Term Capital Loss(LTCL) can be carried forward for up to eight years and adjusted against LTCG only.
Conclusion:
Employee stock ownership plans are generally beneficial for employers and employees, as they encourage greater effort and commitment in exchange for increased pay. However, they are not always straightforward and can create confusion for participants who do not fully comprehend their plan’s terms.
There are different types of ESOPs. To maximize this benefit and not lose out on a big extra bonus, it’s important to know the rules regarding the vesting period and the selling of ESOP shares.
Frequently Asked Questions(FAQS)
- Can I sell my ESOP shares?
ESOP shares can be sold once you complete the employer’s vesting period. The selling process involves Tax liability which is calculated based on the Rule and regulations given by the Indian Revenue Service(IRC).
- How to convert ESOP to shares?
The “Exercise option,” lets you convert the ESOP shares in your name once you pay the amount to the company.
- Does sudden termination of employment affect ESOP?
After the vesting period, an ex-employee can sell the ESOP shares at any time. Employees who don’t complete the vesting period cannot benefit from the ESOP.