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An employee stock option plan (Esop) is an employee benefit plan under which an employee has the right to acquire shares of his employer organisation at discounted value. Attracting and retaining competent professionals is becoming increasingly challenging,especially in a buoyant economy. Besides cash rewards,it is important for any organisation to make its employees believe their personal growth is linked to that of the organisation and that Esops are a mechanism to share such growth.
With capital markets gaining positive movement,many companies are considering Esops as incentives for their employees. This trend is also seen in start-up companies,which are contemplating to go public in the near future. The distinct feature in devising a share-based incentive plan is that under such a scheme,the capital market pays the upside to the employees of listed companies. Under a bonus/deferred cash payment plan,it becomes a cash flow issue for the company,since it needs to shell out cash. Hence,most companies prefer share-based plans to incentivise their employees.
Employee benefit
From an employees perspective,Esops are the preferred options,as they have a right to acquire shares at a pre-determined price,but they are under no obligation to do so. Generally,the options are granted to employees at discounted value. Many companies consider wealth creation as one of the key objectives while designing an incentive plan for their employees. Any shared-based incentive mechanism helps employees create a sound wealth base.
Employee taxation
Benefits arising under a stock-based incentive programme offered to employees by virtue of an allotment or transfer of securities,is now taxed as perquisite in the hands of employees. The perquisite value is computed as the difference between the fair market value (FMV) of the shares on the date of exercise of options and the exercise price. The rules for determining the FMV of shares have been specified. Further,to compute capital gains,the FMV on the date of exercise,would be considered as the cost basis. The capital gains tax treatment depends on multiple factors like the period of holding and whether securities transaction tax has been paid on sale of shares.
The key issue for firms is where an employees salary entitlement is lower than the tax liability on account of perquisite value determined on exercise of options under Esops. In such a case,the employer may not be able to withhold tax to discharge tax obligations. Despite the tax,accounting and regulatory implications,Esops are the flavour of the season,both for employers and employees. Many firms consider share-based incentives as a robust employee-retention tool. Eligible employees consider this as a wealth-creation device for long-term savings.
*The writer is executive director,KPMG
