Employer
Published 22 June, 2020

When and How You Make Money From Company Offered Shares? (8 min read)

This is generally the question all of us have to deal with, unless we are either an expert in compensations and benefits or a financial services geek.

Well, this is our effort to simplify the puzzle. Without getting into too much of finance jargon and confusing the hell out of you, we would try to keep it as simple as we can.

We would cover the following in this blog-

·        Ways an employer can offer shares to an employee/prospective employee

·        Key stages of the whole cycle of the employee being eligible to own the shares, to selling the shares and making money out of it.

·        What are the tax implications for the employee at the various stages

·        How tax implications differ based on the type of company your employer is i.e. Listed company or non listed company

While there are few other ways but the most common way that employers offer shares to it’s employees is either in the form of Employee Stock Options (ESOP) or Restricted Stock Units (RSUs).

Lets talk about RSUs first-employer offers you a certain number of company shares which you can own as per a timeline or milestone based schedule. This schedule is called the “vesting” schedule. As employers use shares as an incentive for employee retention, generally the vesting schedule is designed in a manner where the larger incentives or larger part of the RSUs are vested towards the end of the vesting period. e.g. Post  year 1 employee can own 10% of the RSUs, end of year 2 he/she gets to own additional 40% of the shares and end of year 3 the remaining 50% of the RSUs. What is the price at which you own the shares ? Whatever is the current market price of the share at that time, that multiplied with the number of shares you own is the value of your shares. Below table will explain this very simply to you-

Timeline (in months)

12 

24 

36 

RSUs vested

10

40

50

Share price

100

120

150

Value at the time RSU is awarded

1, 000

4, 800

7, 500

Total value of RSUs at the end of 36 months*

                                                   15,000

*At 36 months all 100 shares are valued at 150 each
hence total value is 15k

 

Are we good till now? Let’s talk about Employee Stock Options (ESOPs).As the phrase suggests, it is an “Option”. The employer offers you an option to buy shares at pre-decided timelines as agreed between both parties. So the vesting schedule applies to ESOPs too. However, one of the major differences between RSUs and ESOPs is that in case of ESOPs you get the option to buy the shares at a pre determined price, which is called the “Strike Price”. This strike price is generally lower than the current market value of the share. The other difference is that the employee has to buy the shares first at the strike price before he/she can sell them to make money.

A simple example can be used to illustrate the point. A particular employee is offered 1000 ESOPs’ by his employer with a vesting period of 3 years from 1st September 2016. The price agreed upon is INR 100 per stock. On 1st September 2019 the employee is entitled to exercise his/her option and purchase 1000 of the company’s stock at the pre-determined price of INR 100.

Now as an employee, it is not mandatory for you to own the shares once you complete milestones, it makes you eligible to own the shares but you sure can choose not to exercise your right to own the shares immediately after becoming eligible. The right can be exercised within a stipulated time (which is agreed upon during the employee’s appointment) post being eligible, beyond which the privilege expires, the period is known as the “exercise period”. The employee can choose not to exercise the right all together for whatever reason it might be.

For example, If the market price of the stock on 1st September 2019 is INR 150, the employee can immediately sell-off the stock holding and make a profit, while if the price of the stock is INR 80, employee may not exercise the option of making the purchase at the pre-determined price.

Calculating Taxes

ESOPs are taxed at 2 instances –

1.)    At the time of exercise – as a perquisite. When the employee has exercised the option, basically agreed to buy; the difference between the Market Value and Stike price or the exercise price is taxed as perquisite. The employer deducts TDS (Tax Deducted at Source) on this perquisite. This amount is shown in the employee’s Form 16 and included as part of total income from salary in the tax return.

 

Below table will explain this further-

Tax Calculation at time of Exercise

Market Price of share on exercise date

100

Strike Price/Exercise Price per share

50

Total shares owned

100

Taxable amount- (Market Price - Strike Price)* No. of shares

5000

Type of Tax

Income Tax

% of tax to be paid is calculated as per Income tax slab relevant for the employee

 

 

Note*-Budget 2020 amendment: From the FY 2020-21, an employee receiving ESOPs from an eligible start-up need not pay tax in the year of exercising the option. The TDS on the ‘perquisite’ stands deferred to earlier of the following events:

  1. Expiry of five years from the year of allotment of ESOPs
  2. Date of sale of the ESOPs by the employee
  3. Date of termination of employment

2.)    At the time of sale by employee – as a capital gain. The employee may choose to sell the shares once these are bought by him. If the employee sells these shares, another tax event happens. The difference between Sale price and the Market Price on the exercise dateis taxed as capital gains.

Tax Calculation at time of sale of shares

Current Market price of share

150

Price of share on exercise date

100

Total shares owned

100

Taxable amount - (Current Market Price - Market Price on Exercise Date)* No. of shares

5000

Type of Tax

Capital Gains

% of tax to be paid is calculated as per type of capital gains. In case the shares are sold with 12 months of exercise date the it would fall under short term capital gains which are taxed at 15% of the profits. If shares are sold after 12 months of exercise date then it would be taxed as Long term capital gains which is taxed at 10% of the profits

 

Tax Calculation for RSUs

Again like ESOPs, RSUs are also taxed at two instances

1.)    At the time of vesting- Since there is no strike price for RSUs, the entire amount is taxed basis the income tax slab which is relevant for the employee.

2.)    At the time of sale of the shares- Here the differential between the sale price of the shares and the exercise price is considered as profit and taxed as Capital Gains.

Can you sell the shares immediately after you own them?

It depends on the type of company that your employer is. If your employer is a public limited company, which means it’s shares are freely traded in any of the stock exchanges then you can sell the shares whenever you want to, once you start owning them.

However, if your employer is a non listed company whose shares are not traded in any stock exchange, then you can only sell the shares during certain specific “events”. e.g. Acquisition of the company or a new funding round which allows employees to sell shares to the new investor or a special offer by the company management to buy back shares issued to employees or during an Initial Public Offering (IPO), which is when your employer becomes a listed company on a stock exchange.

So, this above piece of information is an important one to consider, especially when you are being offered shares of a non listed company e.g. Startups. The wealth that you create would remain notional till the time you are not part of any of the above mentioned “events” wherein you would be able to actually cash the value of the shares you own.

How is sale price of the share determined?

For listed companies, the price is determined by the stock market. For the unlisted companies it is essentially decided by a Merchant Banker.

Well that’s it. Hope this has left you more informed about RSUs and ESOPs than when you started reading this blog.

 

Cheers !

 

Subscribe to stay updated about the latest on Reviewia