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FREE online courses on ESOP - How Does ESOP Work - Rules & Regulations

 

 

Companies Act

 

Issue of stock options requires approval of shareholders by way of a special resolution as per section 81(1 a). This is not applicable for private companies who can issue stock options without shareholder approval but approval by the board of directors.

Income Tax Issues

 

For employees:

 

Till recently, the difference between the cost of the share to the employees and market value on the date on which an employee got the share would be taxed as perquisite in addition to capital gains tax payable by the employee on sale of those shares.

 

However with the recent announcement by the Finance Minister the perquisite tax has been removed. Tax is now payable only at time of sale of shares as capital gains.

 

Since perquisite tax has been removed employers are not liable for tax deduction at source, thus removing administrative inconvenience.

 

For the company:

As per SEBI guidelines listed companies have to account for ESOP by treating the same as an expense. As yet there is no clarity whether this expense will be allowed as deductible expense by the Income Tax authorities.

 

RBI Regulations

 

ESOP of Overseas Parent Company

Reserve Bank of India permits acquisition of shares of overseas parent Company by employees of the Indian Company subject to the following: -

  • The overseas parent Company must hold at least 51% shares in the Indian Company
  • The shares must be offered at a concessional rate. The discount can be from the parent or the Indian company.

 

  • The maximum entitlement is US $ 10000 per employee in a block of 5 years. Permission for an individual employee is not required and the monetary limit of USD 10000 does not apply if shares are being offered to the employees in lieu of Bonus.
  • In case of a cashless exercise of options the above guidelines do not apply provided gains made by the Indian employee are repatriated to him through normal banking channels immediately.

 

ADR / GDR Linked ESOPs

 

There is also a scheme for employees of software companies in India to have ADR/GDR linked stock option plans, which should satisfy the following criteria:

 

  • Companies whose turnover from software activities is not less than 80% can grant stock options to non-resident and resident permanent employees (including Indian and overseas working directors) of the company as well as its subsidiary, but not to promoters and their relatives (as defined in the Companies Act).
  • Employees can remit up to U.S. $ 50,000 in a block of five years for acquisition of ADR/GDR and on liquidation of the ADR/GDR holdings the proceed have to be repatriated to India unless permission from RBI is obtained for its retention or use abroad.
  • The maximum limit is 10% of issued and paid up equity capital and the maximum discount is 10% to the market price prevailing at the time of issue of the stock option.

 

SEBI Guidelines

 

The SEBI guidelines are applicable only to companies listed in India and are as follows:

           

Who is covered?

 

Any employee except the promoter or director (holding more than 10% equity)

Requirements

 

  • Setting up of Compensation Committee of the board, for administration and superintendence of ESOS - the majority being independent directors.

 

  • Shareholder Approval – Any ESOS has to be approved by shareholders, through a special resolution in the general meeting, disclosing to them details about the ESOS like – the total number of options to be granted; identification of classes of employees entitled to participate in the ESOS; requirements of vesting and periods of vesting; the appraisal process for determining the eligibility of employees to the ESOS; maximum number of options to be issued per employee and in aggregate.

 

 

  • Disclosure in the Director's Report – The Board of Directors has to disclose all the details of the ESOS including employee-wise details in the Director's report.

 

  • Compliance with Accounting Policies

 

  • Certificate from Auditors that the scheme has been implemented according to the guidelines and in accordance with the resolution of the company in the general meeting.

 

Non-variation of terms of ESOS

 

Terms of the ESOS cannot be varied in any manner, which may harm the interests of the employee. However they may be changed through a special resolution in a general meeting provided the employee has not yet exercised the ESOS.

 

Pricing

 

Companies have the freedom to determine the exercise price subject to conforming to the accounting policies specified. Any discount from the fair market value has to be reflected as deferred employee compensation in the accounting entries.

 Lock-in period & Rights of the option-holder

 

 

The company has the freedom to specify the lock-in period, there being a minimum period of 1 year between the grant of options and vesting of options.

The employee will not enjoy the benefits of a shareholder, till shares are issued on exercise of option

The company, if any, at the time of grant of option may forfeit the amount payable by the employee, if the option is not exercised within the exercise period or may be refunded to the employee if the options are not vested due to non-fulfilment of condition relating to vesting of option as per the ESOS.

 

Non-transferability of option

 

Options granted to an employee shall not be transferable to any person. In the event of the death of employee while in employment, all the option granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.

 

US GAAP

 

Accounting for Employee Stock Option Plans in accordance with US GAAP is governed by statement No.123 (FAS 123), Accounting for Stock Based Compensation issued by the Financial Accounting Standards Board (FASB) and opinion No.25 (APB25) Accounting for Stock issued to Employees issued by the Accounting Principles Board.

 

  • In the US GAAP Hierarchy FASB statements and interpretations override APB opinions. FAS 123 states that companies issuing stock options must value the options on the date of grant, using a option valuing model, preferably Black Scholes and the value of the option has to be treated as compensation cost, to be recognized over the service period, which is usually the vesting period.

 

  • However, FAS 123 also allows for companies to account for employee stock options using the intrinsic value method prescribed by APB 25. Under the intrinsic value method, compensation cost is the excess of the quoted market price of the shares on the grant date or other measurement date over the exercise price.

 

  • Companies choosing to follow the intrinsic value, method must make Performa disclosures of net income and EPS as if the fair value method prescribed by FAS 123 had been followed.

 

  • In case of variable plans like Stock Appreciation Rights and other plans where the number of shares, exercise price or both are contingent on a future event, the accounting treatments is based on the share price at the balance sheet date. For example, in case of Stock Appreciation Rights with a vesting period of 2 years with grant price being market price on grant date (say Rs.100), entitling the holder to receive the appreciation in market price over the grant in the form of shares.

 

If the SARs are granted on 1.4.2000 and the market price on 31.3.2000 is Rs.200, then Rs.100 will have to be treated as compensation cost, to be amortized over 2 years.

           

FASB has also issued a final interpretation of APB 25, primarily covering: -

Treatment of equity awards to non-employees

Modifications of existing awards

 

 

 

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