Know all about Employee Stock Option

Last Updated On: Aug. 12, 2020, 5:43 p.m.


What is Employee Stock Option (EPSO)?

ESOP is a contract that gives employees the right, but not the obligation, to purchase or subscribe to a specified number of shares of the company at a fixed price, that is, the exercise price. The exercise price remains fixed even if the market price goes up in the future.

ESOP is a system by which a company allows its employees to purchase shares of the company. Such as, a foreign holding company provides the employees of an Indian subsidiary with such an option. Under this scheme, employees are granted options, which allows the employee to buy the stock at a rate below the prevailing market value of the stock or the employee is provided a certain percentage of his/her remuneration in stocks of the company.

It is a trend followed by startups of giving ESOP’s, which cannot afford to provide large compensation packages to its employees. By providing an employee with an ESOP, the employer gets the employee vested in the interests of the company and provides the employee with a sense of ownership, thereby, motivating the employee to perform a task with an actual vested interest in the company.

Some companies provide ESOPs to employees which can be exercised on a future date, to provide an incentive for a long term commitment by the employee to the company.



1. Acquiring the shares of a departing owner: The owners of private companies can use the ESOP to sell their shares. Companies are allowed to make tax-deductible contributions to the ESOP to buy out the shares or the company can use the ESOP to borrow money to buy the shares.

2. Borrowing money at a lower after-tax cost: Cash borrowed under ESOP is used to buy company shares and shares of existing owners. Contributions to the ESOP are tax-deductible as they are made to repay the loan amount. Both principal and interest are tax-deductible.

3. It Creates an employee benefit: A company can issue treasury shares or new shares to an ESOP and deduct the value from the taxable income. Companies sometimes contribute cash to the ESOP to buy shares from existing public or private owners. In public companies, ESOPs are often used in conjunction with the employee savings plan. Rather than matching the employee’s savings through cash, the employers can match the employee’s savings through stocks from an ESOP, and usually, the employers will match the savings at a higher level through stocks.



1. Preparation of list of eligible employees for ESOP:

This is the first step and basic step required for the ESOP scheme. Employees should be carefully selected for participation in the ESOP scheme after considering his/her experience, roles, and responsibility, etc.

2. Preparation of ESOP policy:

It is the most important step for Companies. Following are essential things that must be kept in mind while drafting ESOP policy:

  • Quantum of ESOP pool;
  • Employees Selection and evaluation criteria for participating in the scheme;
  • Rights of option holders;
  • Rights of shareholders like Tag along, Drag along and pre-emption rights;
  • Exit mechanism;
  • Tax liabilities.

3. Board Approval:

After preparation of the list of eligible employees, the quantum of options, drafting of ESOP scheme, the next step is to convene a Board Meeting for final board approval. Boards have to approve list of employees participating in the scheme, draft ESOP scheme, a notice of general meeting for approval of shareholders.

4. General Meeting:

General Meeting of members of the company will have to convene for their approval of the ESOP scheme by Special Resolution. However, Only Ordinary Resolution is required for issue ESOP by Private Limited Company.

5. Filing of Form MGT-14:

E-form MGT-14 must be filled by all the companies (Except Private Limited Company) attaching Special Resolution for approval of Scheme, Explanatory Statement, Notice of GM, and approved ESOP policy.

6. Preparation & Dispatch of Grant Letter:

After approval of shareholders, Company needs to send Grant Letter to all the eligible shareholders to participate in the scheme mentioning their entitlement, vesting schedule, date of vesting, last date up to which exercise can be made, exercise price, manner of exercise of options and other terms and conditions.

7. Vesting of ESOPs:

There must be a minimum 1-year time gap in between granting of option and vesting of the option. For e.g: If you grant the option on 01st April 2019, it can’t be exercised before 01st April 2020.

8. Exercise of ESOPs:

After completion of the vesting period, employees can apply for shares or further wait up to the last date on which exercise can be made or not apply for the shares. ESOP grants only rights and no obligation to employees for the purchase of shares.

9. Allotment of Shares:

If shareholders apply for shares, companies need to allot the shares and file e-form PAS-3 for allotment of shares by attaching Special or Ordinary Resolution for approval of ESOP, Resolution for allotment of shares, list of allottees etc.

10. Issue Share Certificate & Payment of Stamp Duty:

The company need to issue a share certificate to the shareholders within 30 days after allotment. Companies need to pay stamp duty on the issue of shares according to the stamp rates prevailing in the state.



The gains that arise out of the sale of ESOPs are considered as Capital Gains and thus, the Capital Gains Tax is levied on ESOPs and it is to be paid in the year in which such sale has been made. Capital Gain is computed as the difference between the price at which the ESOPs are sold by the employee and the price at which it was awarded by the Employer.

Further, the Capital Gains treatment depends upon the holding period of the ESOPs. For instance, if such shares are held for a period of less than 12 months or one year, the Short Term Capital Gains [email protected]% is levied and if such shares are held for more than 12 months, the Long Term Capital Gains Tax is levied. This Long Term Capital Gains tax is currently NIL. In other words, if the employee sells his shares given to him through ESOPs, the sale is effectively exempt from Tax.


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