ESOPs And SARs – A Comparative Guide - Capital Gains Tax - India (2024)

20 March 2021

by Faranaaz Karbhari and Ishwar Ahuja

HSA Advocates

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1. What are Employee Stock Options Plans (ESOPs) and StockAppreciation Rights (SARs)?

  • ESOPs are a stock option provided by a companyto its employees, to purchase its shares on future dates and at apre-determined price. They are basically a form of incentive givenout by a company to its employee basis their contribution to thecompany. Further, such an incentive helps the company to motivateits employees to contribute to the growth and profitability of thecompany in future as well.

    ESOPs are defined under Section 2(37) of Companies Act, 2013(CA 2013) and are governed by Section 2(37) readwith Section 62(1)(b) of CA 2013 along with Rule 12 of theCompanies (Share Capital and Debentures) Rules 2014.

    There is a minimum vesting period of one year between the grant ofoptions and vesting of option, as per the Regulation No 9 of theSEBI Guidelines, 1999 further, it is to be noted that, as such,there is no such lock-in period involved in ESOPs and the issuingcompany/employer is at liberty to specify the lockin period for theshares issued pursuant to exercise of option.

  • SARs are instruments issued and used by aconglomerate for making stock-based compensation. SARs arealternatives to Employee Stock Option/Purchase Plans/Schemes(ESOPS/ESPS), which are equity based. It may also be called a formof bonus compensation given to employees that is equal to theappreciation of company stock over an established time, but withoutemployee being paying the exercise price.

    Depending on the contractual terms of the respective employee withhis employer, SARs are of can be following two types 'equitysettled' and 'cash settled'. SARs which are settled byway of shares of a company are called as equity settled SARswhereas a SAR which entitles an employee the right to receive cashpayments after a specific period of time or upon fulfilment ofspecific criteria is called as cash settled SARs.

    A company is needed to make a provision in its P&L accounteach year, depending on how the price of shares vary each year, butthis option of compensation to employees may not be suitable tocompanies which are not cash rich. While the CA 2013 has prescribedrules for issuance of shares to employees under Stock Plans, it issilent on the grant and exercise of SARs including issuance ofequity settled SARs and Phantom Stock Options or Cash SettledSARs.
    The companies by issuing SARs contemplate to pass on theappreciation in the value of a certain number of equity shares totheir employees in the value of a certain number of equity sharesto their employees, unlike ESOPs. The company is also saved fromdiluting its rights as a result of which its shareholding remainsunaltered. The primary benefit to the employee, that comes withSARs, is that the employee can receive proceeds from stock priceincreases without being required to buy anything outright.

2. What are the stages involving the process of issuance ofESOPS? What are the key phases relating to SARs?

ESOPs And SARs – A Comparative Guide - Capital Gains Tax - India (2)

3. Which provisions of Income Tax Act, 1961 govern ESOPs andSARs transactions? ESOPs

Prior to the Finance Act, 2009, ESOPs were covered under theFringe Benefit Tax (FBT), but thereafter they have been madetaxable at the hands of the employee as 'perquisites',subject to certain conditions. Relevant provisions under the ITA,which deal with ESOPs and gains from their redemption are set outas under.

  • Section 17 – "Salary","perquisite" and "profits in lieu of salary"defined.
    • (2)(iii) the value of any benefit or amenitygranted or provided free of cost or at concessional rate in any ofthe following cases—
      1. by a company to an employee who is a director thereof;
      2. by a company to an employee being a person who has asubstantial interest in the company;
      3. by any employer (including a company) to an employee to whomthe provisions of paragraphs (a) and (b) of this sub-clause do notapply and whose income under the head "Salaries" (whetherdue from, or paid or allowed by, one or more employers), exclusiveof the value of all benefits or amenities not provided for by wayof monetary payment, exceeds fifty thousand rupees:
    • (2)(vi) the value of any specified security orsweat equity shares allotted or transferred, directly orindirectly, by the employer, or former employer, free of cost or atconcessional rate to the assessee.

      Explanation – For the purposes of this sub-clause -

      1. "specified security" means the securities as definedin clause (h) of section 2 of the Securities Contracts (Regulation)Act, 1956 (42 of 1956) and, where employees' stock option hasbeen granted under any plan or scheme therefor, includes thesecurities offered under such plan or scheme;
      2. "sweat equity shares" means equity shares issued by acompany to its employees or directors at a discount or forconsideration other than cash for providing know-how or makingavailable rights in the nature of intellectual property rights orvalue additions, by whatever name called;
      3. the value of any specified security or sweat equity sharesshall be the fair market value of the specified security or sweatequity shares, as the case may be, on the date on which the optionis exercised by the assessee as reduced by the amount actually paidby, or recovered from, the assessee in respect of such security orshares;
      4. "fair market value" means the value determined inaccordance with the method as may be prescribed;
      5. "option" means a right but not an obligation grantedto an employee to apply for the specified security or sweat equityshares at a predetermined price;

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The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circumstances.

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I'm an expert with extensive knowledge in the field of Employee Stock Options Plans (ESOPs) and Stock Appreciation Rights (SARs). My expertise is grounded in a deep understanding of legal frameworks, regulatory guidelines, and taxation aspects related to these financial instruments. Now, let's delve into the concepts discussed in the provided article:

Employee Stock Options Plans (ESOPs):

  1. Definition and Purpose:

    • ESOPs are stock options granted by a company to its employees, allowing them to purchase company shares at a predetermined price on future dates.
    • These serve as incentives, motivating employees to contribute to the company's growth and profitability.
    • Governed by Section 2(37) of the Companies Act, 2013, and regulated by Section 62(1)(b) along with Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.
  2. Vesting Period:

    • There is a minimum vesting period of one year between the grant of options and the vesting of options, as per Regulation No. 9 of the SEBI Guidelines, 1999.
    • No mandatory lock-in period; the issuing company can specify the lock-in period for the shares issued after option exercise.

Stock Appreciation Rights (SARs):

  1. Definition and Types:

    • SARs are instruments used for stock-based compensation, serving as alternatives to ESOPs.
    • Two types of SARs:
      • Equity Settled SARs: Settled through shares of the company.
      • Cash Settled SARs: Entitle employees to receive cash payments after a specific period or upon meeting specific criteria.
  2. Accounting and Compensation:

    • Companies issuing SARs aim to pass on the appreciation in the value of equity shares to employees without diluting their shareholding.
    • Companies need to make provisions in their Profit and Loss (P&L) account each year based on the fluctuation in share prices.
  3. Advantages to Employees:

    • Employees can benefit from stock price increases without the need to buy shares outright.

Stages of ESOP Issuance and Key Phases Relating to SARs:

  1. ESOP Issuance Stages:

    • The article doesn't explicitly detail the stages, but typically, ESOP issuance involves planning, approval, grant, vesting, and exercise.
  2. Key Phases Relating to SARs:

    • The article doesn't provide specific details on the key phases of SARs issuance.

Provisions of Income Tax Act, 1961 Governing ESOPs and SARs Transactions:

  1. ESOPs Taxation:

    • Before the Finance Act, 2009, ESOPs were covered under Fringe Benefit Tax (FBT).
    • Post-2009, ESOPs are taxable at the hands of the employee as 'perquisites,' subject to conditions.
    • Relevant provisions under the Income Tax Act, 1961, include Section 17.
  2. Definitions and Valuation:

    • Definitions under Section 17 include "salary," "perquisite," and "profits in lieu of salary."
    • Explanation provides definitions for "specified security," "sweat equity shares," "fair market value," and "option."

In conclusion, the article provides a comprehensive overview of ESOPs and SARs, covering their definitions, regulatory frameworks, taxation under the Income Tax Act, and the advantages they offer to both companies and employees.

ESOPs And SARs – A Comparative Guide - Capital Gains Tax - India (2024)
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