Submitted by: ANKIT JAIN 119RAJ JAIN 122AANCHAL SAINI 144ANSHUMAN SARKAR 149KRISHNA GADODIA 113PRACHI LADDHA 159

What are ESOPs?

An Employee Stock Option Plan (ESOP) is a plan wherein a company grants options to its employees.

It allows you to buy the share at a certain price. It could be at a market price or at a preferential price as decided by the company.

ESOPs a compensation tool long followed in the IT sector, are gradually becoming a part of the salary package in media, retail and other high-growth sectors.

Reward top management and "key" employees and link their interests with those of the company

Options are the most prominent form of individual equity compensation

A stock option gives an employee the right to buy a certain number of shares in the company at a fixed price "grant" for a certain number of years

Allows employees to "cash in" by exercising (purchasing) the stock at the lower grant price and then selling the stock at the current market price

Employee Stock Ownership Plans

Equity based contribution benefit plan

Like profit sharing, an ESOP includes at least all full-time employees meeting certain age and service requirements.

Employees do not actually buy shares in an ESOP. Instead, the company contributes its own shares to the plan, contributes cash to buy its own stock (often from an existing owner), or, most commonly, has the plan borrow money to buy stock, with the company repaying the loan.

Eligibility... Employee should have worked with the

company for a minimum of one year

The employee should also be a confirmed employee

The performance rating of the employee for the last one year should be "Exceptional"(L I) or "Very Good"(L2)

Furthermore… The employee should be in a key position in the

company.

The employees should belong to the "must retain" category.

Consistently outstanding performance by the employee is rewarded accordingly.

The decision to award stock options to the employee is taken by the management council.

Limitations

An employee who is a promoter or a part of the promoter group shall not be eligible to participate in the ESOP.

A director who either by himself or through his family or through any investment company, directly or indirectly holds more than 10% of the equity shares of the company shall not be eligible to participate in the ESOP.

Shareholder Approval

The ESOP shall be approved by the shareholders by a special resolution.

The resolution shall contain terms and conditions of the following:

• Identification of classes of beneficiaries entitled to participate In the ESOP.

• Vesting of the Stock Option• Period of exercise and process of exercise.• Exercise price or pricing formula.• The appraisal process for determining the eligibility of

employees to the Stock Option Plan.• Upper limit on the quantum of stock options to be issued in

the aggregate.

Vesting and exercise of options

There should be a minimum period of one year between the grant of options and vesting.

There should be a maximum period of eight years between the grant of options and vesting.

Employee options must be exercised within a maximum period of five years from the date of vesting.

Non transferability

Options shall not be transferable, and only the employee shall be entitled to exercise the options.

They can not be pledged, hypothecated, mortgaged or otherwise alienated in any other respect.

In the event of the death of the employee, while in employment, all the options granted to him as on the date of death shall pass along his estate and shall be fully vested in his estate as on that date and may be claimed by his legal heirs.

How does ESOP work? The ESOP operates through a trust, setup by the

company, that accepts tax deductible contributions from the company to purchase company stock.

The contributions made by the company are distributed to individual employee accounts within the trust.

The amount of stock each individual receives may vary according to pre-established formulas based on salary, service, or position.

The Operation Of the Scheme

The offer letters will be issued by 1 st January, 2009. This will contain the number of shares the employee will get at various dates during the three year period.

If by January 1, 2009 , the employee is not eligible for ESOP , then he will be considered again in January 1, 2001.The employee who becomes eligible in 2003 will get his last instalment of shares in 2007.

The shares will be allotted to the employee via the offer letter for a block of 3 years and will be split into three instalments.

The exact number of shares will be decided on the basis of last year's performance and the length of service from the inception of the company.

All the employees covered by this scheme will also be eligible to receive bonus shares if any.

If there is a rights issue , the employee covered under the ESOP will be eligible to subscribe to the rights issue at the issue price.

If an employees resigns from the company during the time he is covered by the scheme, he will

a.. Not get any share if he leaves before January 1, 2001b. Will get 1/3 of his shares if he resigns after January I, 2001 but before January 1, 2002.c. Will get 2/3 of his shares if resigns after January 1, 2002 but before January l, 2003.

When is it offered?

It is usually dependent on your company policy and your designation.

There are time limits for acquiring it as well. For example, some companies give it after you complete atleast a minimum period of employment.

Stocks are also given in instalments. For example if your company offers you 1000 shares, it might not give you all at one go. Instead you will receive 200 shares after the completion of each year for a span of five years.

Why do Companies offer ESOP?

When you buy and hold the shares of a company, you become shareholders and part owners of the company.

Companies offer ESOPs to employees because having a stake in the company along with wealth generation would also increase motivation to work and loyalty to the company simultaneously.

Basically it is a retention tool by the company.

What is in it for the employees?

Apart from the fact that it is a retention tool, it is a rewarding tool too.

An ESOP is over and above what you get as your salary. For example, say you earn Rs.20,000 per month. Your company

offers you 1000 shares currently priced at Rs.100 each which makes your total worth Rs.1,20,000.

Say after five years you sell your shares, if your company's value shows an upward trend then you make a profit. Plus owning the shares of your company also makes you part owner.

Therefore if you work hard, the company grows, which increases its market value, whereby your share returns increase as well.

Benefits to employees:

Improved relationships between employees and management

Favorable tax treatment compared to other benefit plans

Potential for wealth creation Sense of company ownership for ESOP

participants Increased morale and loyalty ESOP loan is non-recourse to employees Retirement plan correlated with employee

performance

When are they taxed? The ESOP is not taxed on acquiring the shares.

You are taxed on the profit you make when you sell the shares or transfer them.

Transfer here refers to when you gift it to someone or transfer it to someone else under an irrevocable deed (they now own it, not you).

What are the new taxation scheme of ESOP?

The new scheme of taxation of Employees Stock Option Plan initiated by Finance Bill passed on 11th May 2007 and effective from 1/4/2007 is as followsNo taxation of perquisite in hands of employees.Employer to pay Fringe Benefit Tax at the time

vesting of shares in Employees.Employee to pay capital gains tax at the time of

sale of shares received under ESOP.

FM Speak ESOPs are fringe benefits given to the employees and, hence,

they should be taxed Such options are generally given to senior executives, who are

well-off Booming services sector, including software, doesn’t need

incentives

Industry Speak ESOPs help retain talent in sectors where the attrition rates are

high, and help improve productivity But research proves that ESOPs improve productivity and

profitability They are given to freshers and cut across management

hierarchies It does indeed need it if India has to emerge as a global

knowledge hub

How FBT on is ESOP computed?

Section 115WC(1)(ba) gives the method of valuation of ESOP for the purpose of imposing fringe benefit tax.

What the aforesaid provision states in simple

terms is Fair market value (FMV) of shares has to be taken for valuation purpose.

The valuation date for FMV is the date on which the shares are vested in employee.

The value of fringe benefit shall be FMV reduced by amount paid by employee.

The FBT will be charged @ 33.99%

How the FMV is determined?

Central Board of Direct Taxes has not come out with method of Fair Market Valuation.But one should expect that FMV shall be almost equal to average rate on either NSE or BSE on the date of valuation.

What is this vesting of shares? Vesting of shares means the date from when an employee is

allowed to apply or exercise for the specified numbers of shares offered by the company .

Thus there are two limbs of vesting -one vesting percentage and vesting period. 

For example, a company may grant option to an employee on 1/4/2006 for 500 shares. As per the company's ESOP plan, vesting percentage may be 20 % each year with a vesting period of 5 years. Therefore , an employee can apply for 100 shares in each FY starting from Fy 2004-05 till Fy 2009-10.

Lapse of options

It is important to know that ESOPs have an expiration date. That is, even within the vesting period, one can exercise his options only within a particular time window specified in the agreement.

If the options are not exercised within that period, they lapse. This period is called the exercise period.

ESOPs of unlisted companies

In unlisted companies, there is no ‘market price’ or a grant price available for an employee. The company here fixes an internal value to its shares. This is decided by the board of directors of the company through a voting system.

This value is reviewed and re-set periodically. In such cases, an employee can exercise the option if he finds it advantageous and sell the shares back to the company.

A company announces an ESOP plan under which company will allot 500 shares of company to certain employees at a price of Rs 100. Those eligible employees will have option of getting allotment of 100 shares on 1st day of October every year starting from 1/4/2007 for next five years.Let us say, Mr X an employee fills out the ESOP application form on 1.7.2007 for allotment of shares . He is allotted 100 shares on 1/10/2007 . The market value on 1/10/2007 , (vesting day) is RS 500. These 100 shares , let us think , hypothetically, sold by the employee on 31/3/2009 at a price of RS 1200. Then

FBT to be paid by the employer company will be 33.99% on (Rs500-Rs 100)x 100 nos=Rs 16000.Since the vesting date is 1/10/2007 ,FBT will be paid in the year of vesting i.e FY 2007-08 .

There will be long term capital gain on 31/3/2009 since the the shares allotted on 1/10/2007 are hold for more than one year. The long term capital gains shall be computed as under 

Sale consideration RS 1200 x 100 = Rs 1,20,000Less

Cost of acquisition is FMV for FBT purpose i.e Rs 500x 100 =Rs 50,000

Long Term Capital Gains = Rs 70,000

Current scenario:

"IT companies use ESOPs to remain competitive with their multinational peers, who offered big packets and stock options to their employees”.

But with the traditional sector companies getting caught in the war for talent following the increasing competition as well as the entry of multinationals, ESOPs are finding their way among them as well.

Some examples:

Chennai-based Murugappa Group will soon join several other companies from the traditional sectors that plan to offer employee stock option plans (Esops) for the first time to attract and retain talent.

Some more leading names including Omaxe Ltd, DLF Ltd, Purvankara Projects Ltd plan to offer ESOPs to their employees for the first time.

Thank you!!!