ESOP Advantages and Disadvantages

  • Blog|Company Law|
  • 2 Min Read
  • By Taxmann
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  • Last Updated on 2 February, 2021

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Employee Stock Option Plan or Employee Stock Ownership Plans better known as ESOPs, are the options under which a company allows its employees to purchase its shares at a discounted price. Many foreign companies have subsidiaries in India also offer ESOP of foreign companies whereas the employees are working in offices in India.
 
Under ESOP, employees can acquire the company’s shares at price lower than the its market value after fulfilling certain conditions and after certain period of time.

What are benefits of ESOP for the company?

Giving ESOPs is a usual trend in start-ups where the companies give option to its employees, in lieu of high salary, to save high cash outflows, as the resources are limited. This motivates the employees at all levels to work at the optimum level and ensure the company’s growth, as they will also be benefited from the growth of the company.

Here are certain benefits that company may be seeking from giving its employees this plan–

A company could use ESOP to acquire the shares of a departing owner. The owner of private companies can use ESOP to sell their shares in the company. These options are fairly tax deductible option provided by a company to its employees.
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Company may use ESOP to borrow money at lower after tax cost. ESOP is used to buy company’s shares or shares of its existing members. The contribution towards ESOP is tax deductible as they are used to repay the loan amount of the company. Point to be noted here is that both principal and interest are tax deductible. 
This option also allows company to have an employee benefit scheme in terms of employee stock option plan. This was companies could issue the treasury shares to an ESOP and deduct the same value from its taxable income. 

What are disadvantage of ESOP for the company?

ESOP could become an obligation for the company over time. These kinds of shares do not have option premium and only compensation that company gets is in terms of increased liquidity of its venture and savings in some taxes. ESOPs have fair amount of risk which is generally higher than normal stocks as at the time of expiry of the period, the employee may or may not exercise his option. It is only when he exercises his option then the company gets liquidity and amount of that liquidity is uncertain until the date of exercise. 
 
ESOPs when provided by company are non- taxable. Also, the options vested by the employees are non-taxable. ESOPs become taxable when the employee exercises his options then the difference between the market value of the shares and exercise value of the shares is charged to tax as per his tax bracket in which he falls. Also, when he sells the shares and makes some profit out of it then that profit is taxable considering how long the employee have kept the shares and should they be considered as short term capital gain or long term capital gains.

 

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