The Legal Framework Behind Employee Stock Ownership Plans (ESOPs) in India

Employee Stock Ownership Plans (ESOPs) are fast emerging as integral tools for Indian companies for the attraction and retention of talent. In a country where most people now prefer to work for firms where they can have a stake in the business, ESOPs allow employees to benefit directly from the success of the company interest that is matched by the increase in the fortunes of the corporate entity. It covers the basics of ESOPs, India’s legal framework for the same, and cashing out of ESOPs.

What are ESOPs?

ESOPs are a corporate scheme through which the employees are allowed to acquire company shares. It is a good incentive because it allows employees to become stakeholders in the organization and benefit from the company directly through profitability. Any Professional or Individual can learn more about it by pursuing Law courses. The vesting of ESOPs also creates a sense of loyalty and commitment towards the organization as these can also be offered at a discounted price or become vested over a period.

Key Features of ESOPs

• Ownership: Employees, through ESOPs, can become part owners and thus more effectively motivated and work under a culture of ownership.
• Incentivization: ESOPs are generally available at discounted prices, so it serve as a great financial motivator for employees.
• Retention: The ESOPs tend to vest over years encourage the employee to stay with the company and allow the incentives to be extracted in full.
• Wealth Creation: The value of the firm increases and the employee can cash out on her equity through shares.

Types of ESOPs in India

1. Employee Stock Option Scheme (ESOS): In this scheme, a certain number of employees are given an option to purchase shares of the company at a pre-arranged price post a particular period.
2. Restricted Stock Units: These are company shares granted to the employees. However, they have to vest before they are completely owned by the receiver of the shares.
3. Stock Appreciation Rights: Employee rights to receive appreciation in the company’s stock price over a given period for which it is granted.

Legal Framework Behind ESOPs

The employee stock ownership plans, in India, have a strong legal framework since there are various regulatory bodies and provisions of laws that govern them; this means that ESOPs are placed fairly and transparently before the employees. For successful implementation of ESOPs, the companies have to duly comply with various specific provisions under the Companies Act and SEBI regulations as well as provisions of the Income Tax Act.

Companies Act, 2013

The companies are governed by the Company Act 2013 with respect of the issuance of shares in Indian companies and terms and conditions regarding ESOPs. The main provisions are set out as follows:

1. Shareholders’ Sanction: The issue of ESOPs must be sanctioned by the shareholders of the company by passing a special resolution.
2. Eligibility: ESOPs can be offered to only permanent employees, directors other than independent directors, employees of subsidiaries, etc.
3. Vesting Period: At least one year vesting period is required under the Act for the employee to start vesting from the options granted.
4. Disclosure Requirements: The ESOP data that companies are required to disclose includes how many options they granted, for how long they vest, and at what exercise price, in the financial statements for transparency purposes.

SEBI (Share Based Employee Benefits) Regulations, 2014

For listed companies, SEBI rules the ESOPs in its Share Based Employee Benefits (SBEB) Regulations, 2014. SEBI regulations will ensure standardized practices and will protect the investors. Some of the main regulations are:

1. Restrictions on Discount: SEBI mandates that the ESOPs have a fair valuation upon issue. This way, companies cannot issue options at significantly lower rates compared to the market value of the shares.
2. Trust-Based Management: In the case of listed companies, the trusts are invariably established to administer ESOPs and generally adhere to the norms as regulated.
3. Annual Disclosures: SEBI has directed the listed companies to publish their annual estimates of ESOPs in their balance sheets, inter alia, including the total number of options exercised and remaining and other similar disclosures.

Income Tax Act, 1961

Income Tax Act further prescribes the tax implications of ESOPs to employees, which in turn minimizes the same financial benefits employees receive:

1. Under Taxation at Exercise: ESOPs are taxed as non-stock options when employees exercise their options. Amounts of the difference between the FMV of shares and the exercise price are taxed as income.
2. Capital Gains Tax on Sale: The sale of ESOP shares attracts capital gains tax. Again, here it is dependent on the holding period. As with the earlier case, it will be a short-term capital gain if held for less than 12 months and a long-term gain if held for more than that period.

How to Cash Out ESOPs?

The biggest step that employees have to take to gain monetary returns on their stock options would be cashing out ESOPs. Depending upon the company’s policies, there can be some circumstances under which it allows cashing out ESOPs, especially when the company is going public or during buyback programs. Corporate law courses can provide a more clear idea about how to and when to cash out ESOPs. The process for cashing out ESOPs may differ while comparing listed and unlisted companies.

Steps to Cash Out ESOPs

1. Comprehending the Vesting Schedule: Employees should be aware of the vesting schedule so that they can establish at what point options become exercisable. Only the vested ESOPs can be exercised and cashed out. 
2. Exercise the Options: Once a certain vesting period has elapsed, employees are allowed to exercise the options by buying the shares at the set price. This step may require minimal capital investment on the part of the employees as they are buying the shares to become legal owners.
3. Check Company Policies for Cashing Out:
   • On listed companies: employees can offer their shares on the stock exchange depending on the market conditions.
   • For Unlisted Companies: Employees can opt for cashing out through company buybacks, wherein the company buys the shares back at a price determined beforehand. Alternatively, if the company lists itself publicly, employees can sell their shares on the market.
4. Tax Implications: There are tax implications for ESOPs. The difference between the market price and the exercise price while exercising the options has to be taxed. On the sale of the shares, capital gains tax will be levied depending upon the holding period.

Key Considerations for Cashing Out ESOPs

• Timing: The employees must judge the market trend as well as the company’s performance before cashing out.
• Buyback Events: During specific events, some companies offer an ESOP buyback to the employee which enables them to sell the shares.
• Exit Strategy: When a merger takes place, an acquisition is made, or even an Initial Public Offering occurs, the employee can use their share for sale.

Conclusion

Employee stock-ownership plans are a tool of great financial incentive and a sense of ownership, with significant power on both the corporate and employee sides of the relationship. On the employee side, ESOPs allow creation of wealth; on the corporate side, increased engagement and retention for companies result from ESOPs. it is both the employees and employers who benefit when the different financial and legal implications are well understood. Corporate and business law professionals can pursue a course in corporate law or business law, and therefore gain understanding and insight into managing ESOPs, as well as the allied legal frameworks.