Employee Stock Ownership Plan (ESOP) is a kind of employee benefit plan formulated by the Company, through which certain key employees of the company are provided with option to purchase shares in the Company, at a future date, at an agreed price (usually nominal value or at a discount to market value). Most of the Companies these days, majorly start-ups, are resorting to ESOPs as a key measure to retain their employees.

ESOPs provide dual benefits. It provides employees with a sense of ownership in the Company and thereby enhancing the efforts they put in. On the other hand, it enables Company to retain key employees over a long period of time apart from reducing the pressure to pay high salaries to retain the key management personnel.

Further, ESOPs can be time based or performance based. Time based ESOPs are those options which would vest to the Employees on completion of specified time period. Whereas, performance-based options would vest to employees on achievement of certain performance related criteria. Both time-based and performance-based options are widely used in the industry to provide benefits to employees. Generally, time-based options are more used as retention tools whereas performance-based options drive the overall Company performance.

ESOPs are issued by the Companies to employees under a scheme, generally referred to as ESOP Scheme or ESOP Plan. The scheme consists of the key terms of the options issued and the procedural aspects with respect to issue and exercise of options. This ESOP scheme is the overall governing document and specific terms, if any, of the options granted are generally communicated to the employee in the grant letters issued to them.

ESOP scheme formulated by the Company shall comply with the following provisions of The Companies Act 2013, read with Rule 12 of The Companies (Share Capital and Debenture) Rules

AdoptionESOP scheme formulated by the Company shall be adopted by means of Special Resolution*
Persons eligiblea.  Permanent Employee of the Company (in or outside India) b.  Director of the Company (excluding Independent Director) c.  Employees specified above of Holding/ Subsidiary Company
Persons Not Eligiblea. Promoter or persons belonging to the promoter group even though he is an employee/ director of the Company. b. Any director of the Company who directly or indirectly either through relatives or body corporate holds 10% or more outstanding equity shares in the Company.
Company Specific provisions (left to the discretion of Company)a.  Exercise Price b.  Lock-in period for shares issued pursuant to ESOP scheme c. Treatment of the amount paid by employees, if any, at the time of grant of options in case the employee does not exercise his right to purchase the shares issued under options
Additional Resolutionsa. Grant of options to holding or subsidiary Company b. Grant of option to identified employees during any one year equal to or exceeding 1% of the issued capital of the Company at the time of grant. c. varying the terms of Employee stock option scheme (Company shall disclose the rationale of such variation)
Specific Restrictionsa. There shall be a minimum period of 1 year between the grant and vesting of options b. Options granted to Employees are non-transferable, shall not be pledged, hypothecated or mortgaged or otherwise encumbered in any other manner.
Other Provisionsa. Disclosures specified in the rules shall be provided in the explanatory statement annexed to the notice for passing special resolution. b. Disclosures specified in the rules shall be made in the Board report. c. Register of Employee stock options to be maintained and updated regularly. d. In case of a listed Company, SEBI guidelines are required to be complied with.

*Ordinary resolution is required to be passed in case of a Private Company.

Accounting Requirements:

  • Accounting standards require Companies to expense the benefit provided to employees on stock options over the vesting period.
  • Fair value of the Option issued to employee is required to be determined as on the grant date and the difference between the fair value and exercise price is required to be expensed off over the vesting period.
  • Valuation of the stock option is required to be performed by an independent valuer. However, there is ambiguity as to whether registered valuer report is required, or a normal Chartered Accountant report would be sufficient for determination of fair value.

Taxation of ESOPs in the Hands of Employees:

  • At the time of issue:
    • The difference between the fair value as on the date of exercise and the exercise price is taxed as perquisite in the hands of Employee.
    • Fair value for this purpose is required to be determined by a Merchant Banker.
    • Company is required to deduct TDS on the value of perquisite. 
  • At the time of Sale: The difference between fair value as on the date of exercise and the sale value is taxed as long term/ short term capital gain, depending on the period of holding.

Finance Act, 2020 has deferred the taxation of ESOPs in case of start-up Companies. The taxation of ESOPs would be earlier of – 

  • At the end of four years from the date of shares being issued
  • When the employee sells his or her shares
  • When the employee resigns or quits

This has been a great relief to the start-ups considering the lack of liquidity in the hands of employees at the time of exercise of shares allotted by the employer under ESOP scheme.


A properly drafted ESOP scheme document would drive the Company performance to a greater level than compared to its peers and also enhances employee satisfaction in the Company.

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