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How Esops Help Companies in Retaining Top Talent
How Esops Help Companies in Retaining Top Talent

With the growth of start-up positions, ESOPs and RSUs have grown more frequently in India. Several foreign corporations also offer ESOPs to employees in India.

Employee stock option plans (ESOPs) are employee benefit plans that provide employees with a stake in the company. It’s akin to a profit-sharing scheme. The corporation, which is an employer, provides its stocks for insignificant or low costs under these arrangements. These equities are held in an ESOP trust fund until the vesting period, at which point they can be exercised or retired/leave the firm. 

Summary

Employees are usually required to wait a specific amount of time before exercising their entitlement to purchase shares. This is known as the vesting phase. If the employee fails to exercise the option to purchase the shares within the vesting term, the options expire, and the employee loses all rights. IT businesses initiated this trend, but now many companies in many industries provide ESOPs to employees – even startups rely on ESOP to recruit talent.

  • ESOPs increase employee productivity. When ESOPs are established, shares of business stock are distributed to all employees, transforming them into employee-owners who share in the benefits if the stock increases and the risks if the stock falls. As a result, they are more committed to helping the firm flourish and more inclined to solve challenges, such as aiding failing co-workers.
  • Employees are not required to make any out-of-pocket contributions in most ESOPs. Many people find it difficult to contribute to a 401(k) with each payday. An ESOP may be the only retirement system these workers can bear to join.

What is an ESOP?

Employee Stock Option Plans (ESOPs) are also known as Employee Stock Ownership Plans (ESOPs) in India. When an employee receives ESOPs from their employer, they have the right to acquire a specified number of shares in the firm at a predetermined price after a predetermined time or period. It is often offered as a reward for performance or tenure with the organisation. 

It also works as a motivator because when you own stock, you own a piece of the firm, and if the company does well, the stock value rises. Staff stock ownership also plans aid in employee retention. Companies provide ESOPs in installments with a vesting timeline. So, today, an employee may receive 3000 shares, which will be distributed in increments of 1000 over time. 

Retaining Employees Through ESOP

Employees are the fundamental backbone of a firm, without whom an entrepreneur cannot even consider starting a business, let alone making it successful. Hiring great individuals is only the beginning of building a successful staff. 

The second, equally vital step is to keep them with you. High staff turnover costs company owners money and effort. With the rise of the notion of a borderless world, increased financial integration, global company presence, and simple workforce movement, balancing sustainable growth and a pool of talent, therefore ensuring the same or better footing to its Employees as its rivals, has become vital. 

To address the problems of brain drain and employee poaching, incentive compensation systems that connect the needs of both employees and employers for mutual growth and progress must be considered. ESOPs are one of the most complete strategies that have grown through time and are currently actively employed as an employee retention tool.

Employee Stock Option Plans (ESOPs) are acronyms for Employee Stock Option Plans, which allow employees to own a portion of the firm for a little fee. ESOP has acquired an international reputation over the years and is currently a very appealing instrument for employee compensation and retention. Even legislators have paid attention to this issue and included it in statutes.

ESOP is a type of deferred compensation method used by the company, the benefits of which are transferred to the employees over time, resulting in wealth growth for the employee. Employees who believe they have a stake in the firm will work hard to make every penny count. This links his personal goals with those of the corporation, motivating him to stay and contribute to the company’s success. 

ESOPs are a strong retention strategy because they connect workers directly to the organisation’s development or decline by making them intrapreneurs and instilling a desire to work for themselves. Stock option plans are non-cash compensation techniques that operate as a motivator for employee conduct.

ESOPs Benefits For Employees

With ESOPs, an employee gains the benefit of acquiring firm shares at a minimal rate and selling them (after a fixed duration established by his employer) for a profit. There are countless success tales of employees amassing fortunes alongside company founders. Google’s first public offering is a significant example. Its founders, Sergey Brin and Larry Page became the wealthiest people in the world, and stockholder workers made millions as well.

A business may provide stock options to its workers as a form of employee motivation. Employees would be motivated to give their all since they would gain if the company’s stock price rose. Although the primary benefits of ESOP to companies include incentives, employee retention, and rewarding good work, there are numerous other important perks as well. 

Organisations might avoid financial compensations as an incentive with the use of ESOP possibilities, saving on immediate cash outflow. For firms who are establishing or extending their company activities on a larger scale, paying their employees with ESOPs is a more viable alternative than monetary awards.

ESOP Taxation And Calculation

  • There really is no tax when the corporation provides the alternatives.
  • There is no tax when the options vest.
  • When the employee exercises his option to purchase the shares, the difference between the market value and the exercise value is classified as perquisite. It is taxed according to the employee’s tax rate.
  • When the employee sells the stock, the profit is considered a capital gain. If the shares are sold within one year, a 15% capital gains tax must be paid, exactly like any other purchase and sale of shares. There is no tax if the stock is sold after one year since it is considered long-term.
  • If an employee holds an ESOP in India of a firm that is listed abroad and sells the shares, short-term capital gains are added to income, and the employee must pay tax according to the tax bracket in which they fall.
  • If the capital gains are long-term, a 10% tax must be paid without indexation benefits, or a 20% tax must be paid with indexation benefits.

ESOPs are Taxed in 2 Instances –

  • When the employee exercises the option, they have practically decided to buy; the difference between the FMV (on exercise date) and the exercise price is taxed as a perquisite. The employer deducts TDS on this perk. This amount is shown on the employee’s Form 16 and is included in the tax return as part of the total income from salary.
  • Budget 2020 amendment — Beginning in the fiscal year 2020-21, an employee who receives ESOPs from an eligible start-up is not required to pay tax in the year in which the option is exercised. The TDS on the ‘perquisite’ is postponed until the sooner of the following circumstances occur:
    • Five years from the year of ESOP issuance.
    • Date of employee selling of ESOPs 
    • Date of employee sale of ESOPs 
    • Date of job termination
  • The employee may opt to sell the shares after being purchased as a capital gain at the moment of sale. Another tax event occurs if the employee sells these shares. Capital gains are taxed based on the sale price and the FMV on the exercise date. The cost of exercise ——-<Perquisite> ——-FMV on the date of exercise——capital gains> ——the cost of selling

Final Takeaway

As a result, if an employee has received ESOPs from his company, he must first determine if the firm is an eligible startup and whether the requirements for claiming deferred tax payment on such ESOPs issued by an eligible startup are met or not. Employees must also know the fair market value of such ESOPs on the day of exercise in order to determine their tax liability. Such information would be critical in establishing his income tax liability.

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