www.mindspaceconsultants.com Insight into Employee Stock Option Plans CA Sachin Miniyar 21 st January 2012
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Insight into Employee Stock Option Plans
CA Sachin Miniyar
21st January 2012
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Contents
Ø What is ESOP? Ø Need of ESOP Ø Features of ESOP Ø Types of ESOP Ø Applicable Rules and Regulations Ø Accounting of ESOPs
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What is ESOP?
Indian Perspective E – Employee S – Stock O – Option P – Plan
US Perspective E – Employee S – Stock O – Ownership P – Plan
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What is Stock Option?
• Stock Option is a right given to an employee to buy certain number of shares of the company at a fixed pre-determined price over a period of time.
• It has 3 main characteristics: – It is a right and not an obligation. – The price is pre-determined. – The right is available over a period of time.
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Need Of ESOP
• Owners of the company have a basic problem : How do they get their employees to make decisions that are in the interest of the company?
• ESOPs are a powerful motivators because pay offs are linked to market price.
• ESOPs are used as a substitute for cash variable pay.
• Commonly used as an incentive to retain and attract talent.
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ESOP Terminologies
• Grant Price / Exercise Price – The price at which shares are offered to the employees.
• Vesting Period – The period after which the options can be converted into shares.
• Exercise – The action of paying the price and converting the options into shares.
• Exercise Period - The period after vesting within which the employee has to take the decision of exercising Options.
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ESOP Lifecycle
Conceptualizing & Designing
Legal Compliance
Employee Communications
Implementation
Administration
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ESOP Lifecycle
Company Grants Options
Granted Options
Vest
Employee Exercises
Vested Options
Sale of Exercised Options
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ESOP Lifecycle
Grant Vesting Exercise Selling
Vesting Period
Exercise Period
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Year 1 Year 2 Year 3
500 450 400 350 300 250 200 150 100
Share Price Curve
Benefit per share
Exercise Price
How does Employee Benefits
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ESOP Advantages
• No upper cap for the benefit from the scheme.
• Benefits multiply with the progress of the organization.
• Benefit as an owner who has a share in earnings,without entrepreneurial risks.
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Millionaires at Infosys
Options granted in 1995
1 Option at Rs.100/-
100% vesting after 5
yrs.
1:1 Bonus Share Split
1 Option = 4
Shares Total cost
of 4 shares = Rs.100
Market price Rs.
10,000
Benefit per share 10000 – 25 = 9975/-
Benefit from 100 Options Rs.40 lakhs
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ESOP Benefits
A To Company A Attracting Talent A Retaining Key Employees A Reduction in costs by providing non-cash
compensation A Market pays, not the company
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Types of ESOPs
ESOP • Employee Stock Option Plan
ESPP • Employee Share Purchase Plan
SAR • Stock Appreciation Rights
PEP • Phantom Equity Plan
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Applicable Rules & Regulations
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Companies Act
• Need to pass a special resolution in shareholders meeting u/s 81(1A). – Not applicable for private companies. They can issue options
with the approval of Board of Directors.
• Company can grant loan to ESOP Trust to buy its own shares
• Selective buyback of ESOP shares permitted
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ESOP Taxation
GD VD ED SD
Vesting Period
Exercise Period
Holding Period for CG
Perquisite Taxation
Capital Gains
Taxation • On Exercise
Difference between the prevailing price and exercise price taxed as perquisite
• On sale of shares
Difference between selling price and price as on date of exercise taxable as Capital Gains
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ESOP Taxation
• Taxation of Stock Appreciation Rights – Capital Gain / Income under the head Salary / Income from other
sources. – Decision of Special Bench of Appellate Tribunal in Summit
Bhattacharya v. ACIT 16(1) Mumbai [2008] 19 SOT 663 (Mum.)(SB) / 133 TTJ 633
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SEBI Guidelines • Applicability
• ESOS / ESPS
• Eligibility
• Shareholders approval – Special Resolution – Separate resolution for grant to Subsidiary / Holding employees or to
identified employees equal to or grater than 1% of issued capital.
• Pricing and Lock in
• Accounting for ESOPs • Disclosures to Option Holders
• Disclosures in Directors’ Report • Administration of ESOP
• Pre IPO ESOPs
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Accounting for ESOPs
ESOP A/cing
Intrinsic Value Method
Fair Value Method
Intrinsic value means the difference between
the market price & exercise price
Fair value means value as calculated
using binomial valuation model
ESOP cost = No. of options x Value Aggregate ESOP cost to be amortized over vesting schedule
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Accounting Entries
• On Grant of Options Deferred Employee Compensation Expense A/c
To Employee Stock Option Outstanding A/c
• At the end of each year (For amortization of ESOP cost) Employee Compensation Expense A/c
To Deferred Employee Compensation Expense A/c
• At the time of Exercise of Options Bank A/c Employee Stock Option Outstanding A/c
To Share Capital A/c To Share Premium A/c
• If Options lapse Employee Stock Option Outstanding A/c
To Employee Compensation Expense A/c To Deferred Employee Compensation Expense A/c
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Disclosure in Balance Sheet
• Employee Stock Option Outstanding A/c is disclosed in the Balance Sheet under a separate heading, between “Share Capital” and “Reserves & Surplus”.
• Deferred Employee Compensation Expense A/c is disclosed in the Balance Sheet as a negative item under a separate heading, between “Share Capital” and “Reserves & Surplus”.
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Deductibility of Discount on ESOPs • Reasoning in favourable pronouncements
– Loss suffered in course of business would be allowed even in absence of any statutory provision granting such deduction.
– ESOP is nothing but a bonus paid in form of company stocks. – ESOP discount is an ascertainable liability which is recognized in the
books of account.
• Reasoning for unfavourable pronouncements – In case of ESOP, primary issue revolves around the character of
discount (whether capital or revenue?) – Share premium is a capital receipt. Forbearance of such capital
receipt is not deductible. – Employees pay tax on ESOPs is inconsequential in determining the
allowability.
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RBI Guidelines
• Acquisition of foreign securities under ESOP: – Foreign holding not less than 51%. – Shares are offered under cashless ESOP and proceeds are
repatriated to India.
• Permission for purchase of securities under ADR/GDR linked ESOP subject to: – The company belongs to knowledge based sector. – Purchase consideration cannot exceed US$ 50,000 in a block of
5 years . – Scheme has to be in accordance with SEBI guidelines.
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RBI Guidelines
• Issue of shares to non-resident employees: – Face value not to exceed 5% of the paid up equity capital. – Scheme has to be in accordance with SEBI guidelines. – Company to report to RBI details within 30 days from the date of
issue of shares.
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Trends in India
• ESOS is preferred over ESPS.
• Initially implemented only in ICE sector companies.
• Recently manufacturing and service industries have also started implementing ESOPs.
• ESOP is offered over and above the CTC in initial years.
• Retention and reward for performance are common objectives found in many companies.
• Options vest in a graded manner based on time.
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Trends in India
• Uniform structure across organization.
• Most companies prefer direct route rather than Trust route.
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Questions
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