Simplifying Tax for C.A's and Taxpayers
ESOP: An Introduction

ESOP: An Introduction


Definition under Companies Act:

Sec 2(15A) defines employee stock option as

“option given to the whole time directors, officers or employees of a company which gives such directors, officers or employees, the benefits or right to purchase or subscribe at a future date, the securities offered by the company at a predetermined price.”

Above definition can be analyzed to conclude that ESOP involve granting some ownership stake in the company to employees (some or all)  in the form of options at reduced price than what prevails in the market. The personnel can exercise the options only after the vesting period elapses.

Diagrammatically it can be explained as follows:


These terms are explained below:

Important terminologies:


Current legal framework in place for ESOPs in India

The entire legal framework for setting up ESOPs is now in place:

  • The Companies Act, 1956 permits grant of shares and sweat equity to employees.
  • SEBI has also announced detailed guidelines (SEBI (Share based employee benefits) Regulations, 2014. These New regulations replaced the erstwhile The Securities and Exchange Board of India (Employee Stock Option Plan and Employee Share Purchase Plan) guidelines, 1999. ) for grant of Stock Options and Stock Purchase Plans by listed companies.
  • The taxability of gains arising out of exercise of stock options etc. has been clarified through necessary amendments to the Income Tax Act, 1961.
  • The Reserve Bank of India also permits employees of Indian subsidiaries of foreign companies to acquire shares of the foreign holding company.

Accounting of ESOPs

Underlying crux:

  • Employee stock options are a part of the compensation paid to the employee though usually they are granted over and above the fixed and variable cost. Employers engaged in such arrangements with employees recognize the cost of services received over the requisite service period.
  • Accounting value of the options granted should be taken in the books of accounts as compensation cost. The accounting value is determined by finding either fair value of the option or intrinsic value of the option. Intrinsic value means the excess of the fair value of the share at the date of grant of the option over the exercise price of the option. Fair value of an option means the market price of the option, had it been traded in the market.
  • Such compensation cost should be measured as on the date of grant.
  • The cost so arrived at should be amortised over the vesting period or the estimated vesting period as the case may be.

When we account for ESOP, following new accounts come into existence:


Calculation of Compensation Expense / Cost
Screen Shot 2016-05-06 at 1.40.52 PMThis cost is recognized over the requisite service period with a corresponding credit to Employee Stock Options Outstanding account. The number of instruments expected to vest is estimated at the service inception date, and is revised during the requisite service period to reflect subsequent information. Total compensation cost is also revised accordingly. Employees earn the right to exercise the option after the completion of the vesting period, which is generally the service condition.

Booking of Compensation Cost

Equity-settled Schemes:

In case of Schemes in which the Employee gets the Equity Shares of the Company against Exercise of Options, Compensation Cost is recognized by the Employer on a straight-line basis over the vesting period of the options. The entire expense is calculated at the time of grant of Options and it is equally divided over a period within which the options will vest with the Employees, as the case may be.

Cash-settled Schemes:

In case of Schemes, where the Employee gets the incremental value of Company’s Shares over a period of time, the Employer has to make a provision equivalent to the amount to be paid to the Employees in the year in which the payment is to be made.

The Accounting treatment discussed above can be illustrated by the following numerical example.

  1. For Equity-settled Schemes


Therefore, the total compensation cost of Rs. 20,000/- (1000*(30-10)), has to be booked in the year of vesting, by the company in its P&L A/c of the company.

      2. For Cash-settled Schemes


Disclosure requirements By SEBI

  • Accounting policy given by the SEBI (only for listed companies)
  • Director’s report under Section 217  under the Companies Act, 1956, following disclosures to be included:
    • Options granted
    • Pricing Formula
    • Options vested
    • Options exercised
    • Options lapsed
    • Total number of shares arising as a result of exercise of option
    • Money realized by exercise of options
    • Employee wise details of options granted
    • Diluted EPS pursuant to options as per AS 20

Taxation aspects

  • For employee

At the time of receiving options:

For tax purposes, ESOP benefits received by employee will be taxable as perquisite. However:

  • It shall be taxable only when shares are allotted under ESOPs. The perquisite tax needs to be paid on date of exercise even though the shares are not sold.
  • The perquisite tax depends on the tax bracket of the employee.


Determining FMV

  • Where shares in the company are listed on a single recognised stock exchange

FMV shall be the average of opening and closing price of shares on the date of exercise of option.

However, if on the date of exercise of option there is no trading in shares, the FMV shall be the closing price of the share on any recognised stock exchange on a date closest to the date of exercise of option and immediately preceding such date of exercise of option.

  • Where shares in the company are not listed on a recognised stock exchange

FMV shall be such value of the share in the company as determined by a category I merchant banker registered with SEBI on the specified date.

Specified date means the date of exercise of option or any date earlier than the date of exercise of option, not being a date which is more than 180 days earlier than the date of exercise of option.

On holding the shares allotted: Dividends received for shares of the Indian companies are exempt from tax in the hands of the employees/shareholder.

At the time of sale:  The incremental gain on sale of shares is considered a capital gain for the employee.


For computing capital gains, the FMV on the date of exercise becomes the cost base. The capital gains tax treatment further depends on the holding period and whether the shares are sold on a recognised stock exchange in India.

For listed shares where the securities transaction tax is paid, there would be no tax if shares are held for more than one year, but taxed at 15.45% if held for less than one year.

In case of unlisted shares, the tax rate is 20.3%, if held for more than one year; if held for less than a year, it is taxable at normal rates of taxes (based on the income slab).

If ESOPs are of company  listed abroad

This depends on whether you are a resident or non-resident Indian. If you are a non-resident, it will not be taxable, as the gains occur outside India, unless the money is received in India.

If you are a resident in India, then you will be taxed as if shares are unlisted shares

This can be explained with the following example:

Exercise price (EP) of option 100
Fair Market value on date of grant (FMVG) 150
Fair Market value on date of exercise (FMVE)on 12 April 2015180
Perquisite = Calculated on difference between FMVE and EP 80
Sale price (SP)of share on April 10, 2016200
Tax bracket of employee20%
Capital gains = Calculated on difference between SP and FMVE 20

Total tax for A.Y. 2017-18 = Rs 80*20% (Tax on Perquisite) + 20*15% (Tax on Short term capital gain)= Rs 19 (plus cess)

  • For employer:

The Employer can claim deduction for the compensation (as well as other expenses) from firm’s gross income to arrive at its taxable under Section 37(1) of the Income tax Act. However the same is contentious.

The deduction is allowable in the year in which the option is exercised by the employees i.e. when the liability became certain and not proportionately over the vesting period as claimed by the employee.

Since, the perquisite value is added to the salary income of the respective employees, this imposes the obligation on the employer to withhold tax at source under the provisions of section 192 of the Income Tax Act.

New Developments:

  • On August 24, 2015, SEBI clarified that the Sale and purchase of shares under ESOPs would not be considered as ‘trading’ except for disclosure requirements under the new insider trading regulations (the SEBI (Prohibition of Insider Trading) Regulations, 2015)) w.e.f May 15, 2015.
  • The Finance Ministry is considering ESOPs for top management of public sector banks. On August 14, 2015, the finance ministry said it was formulating an ESOP policy for the top management of PSBs. At present, the chief executives and executive directors are eligible for bonus, which will be converted into ESOPs, according to the government’s plan.

Popularity of ESOPs and associated concerns



  2. ICAI Guidance note on Employee Share based Payments
  3. Income Tax Act

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