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Employee Stock Option Plan (ESOP) 1

EMPLOYEE STOCK OPTION PLAN (ESOP)

Employee Stock Option Plan is priceless tool for companies to attract andretain talented employees. As a part of an employee's compensationESOP creates a sense of ownership in the mind of employees and theirinterest in the organization remains intact.

ESOPs are beneficial to both employees as well as the Company, Ifimplemented effectively. ESOPs have two fold benefit i.e. reducing cashoutflow and retaining deserving employees for their growth.

Employees also see this scheme as a long term investment for whichthey have to compensate with their cash perquisites and bonuses.

ParticularsESOP – An Introduction, Flow, Key definitions

ESOP – Eligible Persons, Ineligible Persons, Conditions to Issue of ESOP

ESOP –Methods of issue and Requirements for Issue

ESOP – Taxation of ESOP’s including Section 54 exemptions at the time of exit/sale of ESOP shares

ESOP to Foreign Employee

ESOP from Foreign company

ESOP – FAQ’s

BJAA ESOP Services

THIS NOTE COVERS :


WhatareESOP’s?

AnEmployeeStockOptionPlan(ESOP)isanoption

giventotheemployeestobuythesharesofthe

Company.

AnOptiongivestherighttopurchasethesharesatapre-

determinedprice,andthereforegivesthe

employeeanupsidetothe

currentvalueoftheshare.

However,untiltheoptionisexercisedandconvertedintoashare,anoptionholderdoesnot

getanyshareholderrights

ofvoting,dividendsandthe

like.

• It is a tremendous motivator and can encourage employees involvement in theirjobs and enable them to focus on corporate performance.

• It is vital tool to attract and retain quality employees, fostering in them long termattitudes.

• As a compensation tool, Employee Stock Options offer rewards that can exceedthe expectations of employees but are still affordable to the company as they arehighly performance driven.

• Internationally, Employee Stock Options are used for granting retirement benefitsto employees and as succession plan for owners

WhyESOP?

ESOP – AN INTRODUCTION


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GrantingOption given to an employee which gives the employeea right to purchase or subscribe at a future date, theshares offered by the Company, at a predeterminedprice

VestingThe process by which the right to apply for sharesaccrues to eligible employees against the OptionsGranted to them.

ExercisingMaking of an application by an employee to the Companyfor issue of shares against vested option.

ESOP – KEY TERMS


Granting of options

Vesting of options

Exercise of Options

Sale of Shares

ESOP – FLOW

Formation of Employee Stock Option Plan (ESOP)


Company

Permanent employee of the Company (including Holding or

Subsidiary) who has been working in India or outside India

Director of the Company (including Holding or Subsidiary) (Excluding

Independent Director)

ESOP – ELIGIBLE PERSONS

Company (Cannot issue Employee Stock Options)

An employee who is a Promoter or belongs to the Promoter Group

A Director who directly or indirectly holds more than 10% of outstanding

equity shares of the Company.

ESOP – INELIGIBLE PERSONS

ELIGIBLE STARTUP

“ELIGIBLE START-UP” as defined in Notification G.S.R.501(E) of dated23rd May 2017 would not be subject to the above limitations for a periodupto five years from date of Incorporation or registration.


Time GapAt least 1 year between the grant of options and

vesting of options

Non-transferableEmployee Stock Options granted to the Employees

are not transferable

ValuationValuation of shares at the time of exercise of option

ESOP – CONDITIONS TO ISSUE


Through Trust

§ Trust will be created for Framing andimplementing ESOP

§ ESOP Scheme is run by the Trust

§ Founder/Specific Shareholders transferportion of their shares to Trust to createESOP pool / Company issues shares tothe Trust.

§ Cost of creating/ Maintaining Trust ishigh

Through Direct Route

§ Employee Stock Option poolwill be created by Companythrough the Board of theCompany, shareholderapproval and and creation ofan ESOP Plan

§ The ESOP Scheme is run bythe Board / Other NominatedCommittee of the Company

§ Cost of creating/ ImplementingESOP scheme is relatively low

ESOP – METHODS OF IMPLEMENTATION


Timeline Based

§ Vesting will be in “n” of Years as pervesting Schedule

§ Number of Options to be vested isfixed

Performance based

§ Granting will be based onperformance of Employee

§ Number of Options to begranted will changedepending uponperformance

ESOP – METHODS OF IMPLEMENTATION

Employee Stock Option Plan (ESOP)

Draft ESOP§ Draft ESOP indicating No of ESOP to be

issued, Vesting Period/schedule, ExercisePeriod, Condition for granting if any

§ Company has option to specify Lock –inperiod for shares issued pursuant toexercise of option

Approval of Directors,

Shareholders

§ Convene Board Meeting and approveschemes

§ Call general body meeting of Shareholdersand pass the scheme by passing resolution(special resolution if it is other than privatelimited)

File Forms with ROC

§ File MGT -14 With ROC for Specialresolution

Granting, Vesting, Exercise

§ Granting Options to eligible employeesthrough Letter of Grant.

§ Minimum of 1 year gap between Grantingand Vesting Options

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05Compliance

§ Company shall maintain register of ESOP inSH-6

§ Options shall be disclosed in Director’sReport alongwith details of ESOP

§ When options are exercised, PAS-3 has tobe filed.

ESOP – REQUIREMENTS AS PER COMPANIES ACT 2013

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EMPLOYER

§ In case any shares are issued bythe company under the ESOPscheme on or after 1 April, 2009,then under the provisions of TheIncome Tax Act 1961, there shallbe no tax liability in the hands ofemployer/Company

At the time of Exercise of ESOP

§ Perquisite Taxation : Employeesshall be liable to pay tax on fairmarket value on the date of exercise(-) the exercise price and suchamount shall be liable to be taxed asa perquisite paid by the employer tothe employee under section 17 ofthe Income Tax Act, 1961

At the time of sale of ESOP shares

§ Capital Gains Tax : Employeesshall be liable to pay capital gaintax under section 49 of the IncomeTax, and the tax shall be calculatedon the amount of difference betweenthe Sale consideration (-) the priceat which the shares were acquired(Price on which perquisite tax waspaid)

TAX IMPLICATIONS

EMPLOYEE

ESOP TAX IMPLICATIONS ON ISSUE, EXERCISE AND SALE OF ESOP (1/2)


CAPITAL GAIN SALE CONSDIERATION Less: Expenses on Transfer Net Sale Consideration

Less: COST OF ACQUISITION (FMV ON DATE OF EXERCISE OF OPTION)

CAPITAL GAIN ON SALE OF SHARES

ESOP TAX IMPLICATIONS ON ISSUE, EXERCISE AND SALE OF ESOP (2/2)

§ The Employee Stock Option holder period of equity holding shall bereckoned from date of allotment (exercise of option) or Transfer ofsuch shares as per Explanation to Section 2(42A)

§ Period of holding not more than 24 months is considered as Shortterm Capital assets and taxed at individual slab rate. (Not applicableto Listed Company) - can be used


Particulars Section 54EC Section 54F Section 54EE

Eligible taxpayers Any person Individual and HUF Any person

Capital gains for exemption Long-term Long-term Long-term

Capital gains arising from transfer of

Any long-term capital asset

Any long term asset (other than a residential house property) provided on date of transfer taxpayer does not own more than one residential house property (except the new house)

Any long-term capital asset

Assets to be acquired for exemption

Bond of NHAI or REC, etc.

One residential house property

“long-term specified asset” which means a unit or units, issued before the 1st

day of April, 2019, of such fund as may be notified by the Central Government in this behalf.

Time limit for acquiring the new assets

Within 6 months from date of transfer

Purchase: within 1 year before or within 2 years after date of transfer. Construction: within 3 years after date of transfer

within 6 months from the date of transfer

Exemption Amount

Investment in new assets or capital gains, whichever is lower, however, subject to Rs. 50 lakhs in a financial year and subsequent financial year

Investment in new assets X (capital gain/net consideration)

Investment in new assets or capital gains, whichever is lower, however, subject to Rs. 50 lakhs in a financial year and subsequent financial year

SALE OF ESOP SHARES / ESOP EXIT : TAX EXEMPTIONS


ESOP to Foreign Employee(Requirements for an Indian

Company)


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§ The ESOP is drawneither in terms ofregulations issuedunder the Securitiesand ExchangeBoard of India Act,1992 or

§ the Companies(Share Capital andDebentures) Rules,2014 notified by theCentralGovernment underthe Companies Act2013;

“Employee’s stockoption”/ “sweatequity shares” are incompliance with thesectoral capapplicable to the saidcompany

Issue of “employee’sstock option”/ “sweatequity shares” in acompany whereinvestment by aperson residentoutside India isunder the approvalroute requires priorGovernmentapproval.

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CONDITIONS TO BE FULFILLED

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At the time of Granting

§ The issuing company shall furnishto RBI within 30 days from the dateof issue of ESOP or sweat equityshares, a return as per the Form-ESOP

At the time of exercise of

options

§ Indian Company has to obtain KYCof each Employee

§ File ARF in 30 days of receipt offunds and FCGPR in 30 days withRBI for the Foreign Investment

CA and CS Certificate

§ CA Certificate as prescribedalong with CS Certificate foradherence to FEMA guidelines

File Annual Statement with

RBI

§ File annual statement of assetsand liabilities with RBI

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05Valuation for

Entry and Exit§ Exit price can be any price less

than or equal to fair value asdetermined by CharteredAccountant

REPORTING REQUIREMENTS - FEMA

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ESOP from Foreign Parent company to Employee of Indian

Subsidiary(Requirements for an Indian

Company)


FEMA

§ General permission has beengranted to a person resident inIndia who is an individual topurchase equity share offered byForeign companies under ESOPif he is an Employee, director ofForeign Company/Subsidiary ofForeign Companies

§ Shares under ESOP Schemeoffered by issuing companyglobally on uniform basis

§ An Annual Return (Annex – B) issubmitted by Indian company toRBI through AD Category – Igiving details of remittances/beneficiaries

Companies Act

§ In compliance of Section 170 ofCompanies Act, 2013 & Rule 17of Companies (Appointment andQualifications of Directors) Rule,2014, Register of Directors andKMP with their Shareholding isto be maintained by everyCompany.

§ According to which, the details ofsecurities held by Directors andKMPs in the Company or itsholding, subsidiary, subsidiary ofcompany’s holding company orassociate companies shall bedisclosed/filled in with saidRegister.

FEMA and Companies Act

REPORTING RESPONSIBILITY –RESIDENT


1) What is the difference between Employee Stock Option Plan (ESOP) andEmployee Stock Purchase Scheme (ESPS) ?

§ In ESOP the company grants an option to its employees to acquire shares at afuture date at a pre-determined price. Eligible employees are free to acquire shareson vesting within the exercise period. Employees are free to dispose of the sharessubject to lock-in-period if any. Generally exercise price is lower than the prevalentmarket price.

§ ESPS is generally used in listed companies, wherein the employees are given theright to acquire shares of the company immediately, not at a future date as inESOS, at a price lower than the prevailing market price. ESPS will be subject tolock-in-period of 1 year, the employee cannot sell the shares and/or the employeehas to continue with the employer for a certain number of years. The company canoffer shares to employees as part of a public issue.

2) What is the difference between ESOP and sweat equity share?

§ Sweat Equity Shares are the shares given to the employee or directors at adiscount or for consideration other than cash, for providing know-how / intellectualproperty rights. These are governed under section 54, read with Rule 8 of ChapterIV of Companies Act, 2013.

§ ESOPs are the options granted to employees by the employer, which can beconverted into Equity Shares on a future date, at a pre-determined price. These aregoverned by Section 62(1)(b), read with Rule 12 of Chapter IV of the CompaniesAct, 2013.

ESOP – FAQ (1/2)


3) If any person has stock options, does it means that he is the holder of theshares?

No the options are not like the owning of the shares, but it is only a right to buy theshares. He shall become shareholder only after the right is exercised in respect ofthose shares.

4) When does taxable event arise?

Taxable event doesn’t arise on granting options. It arises at the time of exercise ofshares

5) Whether shares under ESOP can be allotted in physical mode or it can onlybe allotted in electronic form?

A company may issue shares under the scheme in the physical form or in theelectronic mode; therefore there is no restriction on the company to issue the sharesin the electronic form only

6) Can Company restrict transfer of shares issued pursuant to exercise ofoption?

Yes. Company has option to specify the lock in period at the time of granting.

ESOP – FAQ (2/2)


HOW PEOPLE AND TAX ADVISORY

@BJAA

WILL HELP


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Facilitate on-going Companies Act compliance

Faciliate on going compliance with respect to Companies Act,2013 by Employers

Employee CommunicationsProvide letters of Grant for employee communications for granting of options

Execution of Option AgreementCreating Option agreement and Executing

Accounting through the Exercise periodProvide Accounting support and advise throughout the period

Drafting ESOP SchemeDrafting ESOP agreement depending upon company’s requirement

BJAA SERVICESFacilitate on-going FEMA

complianceFacilitate compliance with respect to FEMA in case of Foreign Employees

ESOP IMPLEMENTATION AT BJAA


Your preferred ESOP Advisory Partners

ESOP Expertise Research on the Compensation

Structures

Qualified Team

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Partners with over 30+years of experience

Offering Host of ProfessionalServices under one roof

Dedicated team ofprofessionals with soundunderstanding andknowledge of the ActReady Checklists and Tool-kits due to on-going andcontinuous research on thelaw

WHY BANSHI JAIN AND ASSOCIATES (BJAA)?


Disclaimer

This note is does not intend to represent tax law nor does it intend to substitute foryour specific tax professionals. Please consult your tax advisor for detailed analysisof your unique tax situation. We accept no duty of care or liability of any kind to therecipient, and any reliance on it is at the recipient’s own risk. This note is a copyrightof Banshi Jain and Associates.

About BJAABanshi Jain and Associates is a leading multi-disciplinary firm rendering focusedprofessional services in areas of Assurance, Tax, Financial Advisory and StartupAdvisory.Banshi Jain and Associates (BJAA) is admired as a name of trust and excellence,with an aim to provide exceptional service delivery through value addition, clientfocus and innovative practices

Service Areas : Audit | Tax | Startups |Transactions | RERA | FEMA

BJAA has offices at : Mumbai, Jodhpur and Raipur. Find out more about us visit us atwww.bjaa.in

About BJAA Startup AdvisoryBJAA Startup | TAS is experienced team focused only on startups and plays an activehands-on role to support distinctive growth challenges these disruptive businessesface at every stage of their business lifecycle.

For more information, please contact Eshank M Shah at [email protected] / +919833113067

About BJAA Co-LearningBJAA Co-Learning is a series of events, updates and shared learningexperiences at the Firm and with Our Clients.

We disseminate accounting, tax and regulatory updates, on-the-job learnings andhold events to keep our team and clients apprised with the changing legislations.


APPENDIX


Foreign Employee

Transfer to Resident in India Transfer to Non Resident

By the way of Sale/ Gift

FOREIGN EMPLOYEE - EXIT


(EXIT)SALE BY NON RESIDENT INDIAN

TO INDIAN RESIDENT

Non-Resident Indian(Seller) Indian Resident (Buyer)

Shares of Indian Company


WITHOLDING TAX

Foreign Resident (Seller)

§ Section 195 : Provide to buyer details required for Computation of Capital Gain

§ Capital Gain Tax Computation

§ Whether shares are purchased in INR (Section 48) OR Foreign Currency (First proviso to Sec 48)

FILE FORM FC-TRS


§ Co-operate in executing Form FC-TRS for effecting transfer of shares

VALUATION REPORT


§ Give Signaturesto Applicabletransfer FormsunderCompanies Act,2013

Income Tax Act FEMA and

Companies Act

RESPONSIBILITY – NON RESIDENT

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RBI APPROVAL

Indian Resident (Buyer)

§ Automatic Route : No RBI Approval for Foreign Remittance of Funds

§ Approval Route : RBI Approval for Foreign Remittance of Funds

FILE FORM FC-TRS

Indian Resident(Buyer)

§ File Form FC-TRS within 60 days of transfer of funds

§ Documents required by AD branch while filing Form FC-TRS

1. Consent Letter for the transfer of shares duly signed by Seller & Buyer.

2. No objection/Tax Clearance Certificate from income Tax authority/CA

3. Undertaking from buyer to effect that pricing guidelines have been adhered

VALUATION REPORT

Indian Resident(Buyer)

§ Obtain ValuationReport from CAcomputing FairValue per Share asper FEMAGuidelines onValuation

§ Exit price cannot bemore than FairValue per share ascertified by aCharteredAccountant

FEMA

RESPONSIBILITY – RESIDENT


FEMA AND PRICING

Foreign Resident (Transferor)

§ No Reporting underFEMA and pricing can beas determined betweenthe parties in Complianceof FEMA and The IncomeTax Act, 1961 (based onresidency of thetransferor)

CHANGE IN SHAREHOLDERS

Foreign Resident (Transferor)

§ Intimate company to giveeffect for change inshareholders

FEMA and Companies Act

RESPONSIBILITY – TRANSFEROR(3/3)


(EXIT)SALE BY NON RESIDENT INDIAN

TO NON - INDIAN RESIDENT

Non-Resident Indian(Seller)

Non- Resident Indian (Buyer)



Non-Resident Indian(Seller/Transferor)

Non- Resident Indian (Buyer/ Transferee)


Constitutes “indirect transfer” under Income Tax Act

RESPONSIBILITY – TRANSFEROR(1/3)


Indirect Transfer of Capital Asset

§ In case of an “indirect transfer” capitalgains tax is payable by the transferoras per Section 9(1) of Income Tax Actread with Section 2(14) and Section2(47)

Compute Capital Gains and pay tax

liability

§ Compute capital gains in hands oftransferor as per Section 45 of IncomeTax Act

§ Transferor to discharge Tax Liability inIndia (Obtain PAN and pay S.A Tax asassessed on Capital Gain)

Check DTAA of India with Transferor

§ Check DTAA between India andTransferor Country

§ Transferor may claim Tax Credit inForeign Country for Tax Paid in India asper DTAA

Claim DTAA Benefit§ For Claiming DTAA benefit : Form

10F, TRC PE Declaration and PANNumber is required

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05Filing Form 15CA

§ Non-resident making payment to anon-resident is required (transferor) tofile Form 15CA

Income Tax Act (TRANSFEROR / SELLER)

RESPONSIBILITY – TRANSFEROR (2/3)

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