What is ESOP?

Retaining a good talent is harder than hiring a new one. As salaries and traditional benefits alone may not be sufficient to attract and retain top talent, many companies use ESOPs to motivate employees and make them feel invested in the organisation's growth and success.

Let’s understand in detail what ESOP is, how it works, the charges involved, and the tax implications so you can make informed decisions.

What is an ESOP?

An ESOP (Employee Stock Option Plan) is a benefit plan offered by companies to their employees, giving them the right and option to buy company shares at a predetermined price after a specified vesting period.

Companies offer ESOPs to reward employees, foster a sense of shared ownership, and align their interests with the company's growth and success. ESOPs can motivate employees to work harder because if the company’s shares increase in the future, the employees can make a profit by selling them.

In India, ESOPs are strictly regulated by SEBI Regulations (Share Based Employee Benefits and Sweat Equity) 2021 for listed companies and the Companies Act 2013 for the unlisted companies.

Taxes applicable on ESOP exercise and selling are levied based on the tax rules under the Income Tax Act, 2025.

Charges Involved in ESOP

ESOP incurs two primary charges: exercise cost and taxation.

When an employee decides to buy the company shares and exercise their option, they have to pay a fixed price to their company. The employee has to pay tax on the notional profit earned, which is the difference between the current Fair Market Value (FMV) and the exercise price.

The company usually deducts Tax Deducted at Source (TDS) at the exercise stage. However, if the company holds eligible DPIIT-recognition and Section 80-IAC certification, the TDS can be delayed for up to 5 years from the grant date until the date the shares are sold or the employee leaves the company.

Tax Implication of ESOPs

The following are the tax implications of ESOP.

At Exercise

When you convert your options into actual shares by paying the fixed price, the difference between the FMV and the exercise price is taxed as a perquisite under your salary income. The applicable tax rate on your exercise price depends on your income tax slab.

At Sale

When the employee sells the shares and earns a profit, they have to pay capital gain tax based on the holding period. If they held the shares for less than 12 months, short-term capital gain tax is applicable, and for holding periods of more than 12 months, long-term capital gain tax is levied.

Benefits of ESOPs for Employees

The following are the benefits of opting for ESOPs.

Stock Ownership

Through an ESOP, employees can gain stock ownership of the company they work for and benefit from the company’s growth and success.

Low Investment Cost

Employees purchase company shares at a predetermined exercise price, which is often lower than the prevailing market value. In the case of unlisted companies, ESOPs provide early access to the business and significant price appreciation if and when the company goes public.

Potential Capital Appreciation

Employees can benefit from capital appreciation if the company grows and performs well in the future, leading to stock price appreciation.

FAQs

What is ESOP?

An ESOP (Employee Stock Option Plan) is a benefit plan offered by companies to their employees, giving them the right and option to buy company shares at a predetermined price after a specified period.

What does ESOP stand for?

ESOP stands for Employee Stock Ownership Plan.

Can employees make money from ESOPs?

Yes, employees can earn money by selling the shares when their price appreciates.

Who can get ESOPs?

Employees completing a specific period of time, usually 1 year, are eligible for ESOPs.

Are ESOPs the same as salary?

No, ESOPs are a benefit scheme that offers employees the right and option to buy company shares at a specific price at a future date.

Can I sell my ESOP shares?

Yes, you can sell them based on your company’s rules.