Employee Stock Options (ESOPs)

With the number of start-ups coming up in India, Employee Stock Options (ESOPs) are getting popular. ESOPs are basically an offer given by a company to the employee to purchase the stock of the company in the future at a discounted price. These are a great option both for the employer who can pay a part of salary to its employees (instead of cash compensation) as well as the employee who can own the shares in the company at a discounted price, which can grow by a lot if the company grows. Let us understand Employee Stock Options in detail.

Some terminologies related to ESOPs

  1. Grant Date: The date on which the ESOPs are offered to the employee.
  2. Grant Price: The price on the date on which the ESOP is offered to the employee. This price does not have much significance and has nothing to do with the taxes or actual value to the Employee.
  3. Vesting Date: This is the date after which the employee can exercise his right to buy the shares of his employer company. This date is agreed upon in the ESOP offer and the employee has the full right to buy shares of the company at the exercise price (explained below) if all other conditions mentioned in the offer are satisfied.
  4. Cliff period: You would receive the benefits of your ESOPs ONLY after you are employed with your company for a certain amount of time, called as the cliff period. For example, suppose you have ESOPs with a vesting period of 4 years (25% every year for next 4 years) and a cliff period of 2 year, you won’t be able to exercise any ESOPs just after after 1 year. However, at the end of 2 years (cliff period), you would be able to exercise 50% of your options, followed by additional 25% after the 3rd year and remaining 25% after the 4th year. This period generally benefits the employer since it needs you to stay employed with the company for longer time before you start owning shares of the company.
  5. Exercise Period: After the vesting date, the employee gets some time to buy the shares from the company (called as exercising the option). This time is called as the Exercise Period. Till the exercise period after the vesting date, the employee has the right to exercise his option (if he finds the shares valuable). If he does not exercise his option within the Exercise period, the offer lapses.
    Note: Till the exercise period, the employee can buy shares as per the conditions mentioned in the ESOP agreement even if he is no longer associated with the company.
  6. Exercise Date: The date on which the employee actually purchases the shares of the company.
  7. Exercise Price: The price at which the employee can purchase the shares of the company. This price is decided on the Grant date.

ESOPs life Cycle

There are basically 4 stages of ESOPs:

  1. Grant: Once you are granted ESOPs, you get into an agreement with your employer. This agreement contains the number of shares the employee can buy (if he wants to), the exercise price and the vesting date of his ESOPs. There may be other terms and conditions related to the ESOPs.
  2. Vest: Once your ESOPs are vested, you get the right to exercise your option to buy the shares within the exercise period by paying the exercise price. Note that the exercising is optional. If you don’t find the shares valuable, you have an option to ‘not exercise’ your options and it will expire automatically after the exercise period is over.
  3. Exercise: If you decide to exercise your option, you have to pay the exercise price to your employer and in return, you’ll receive the shares in your demat account. You can exercise all the ESOPs at a time or you can exercise it in parts. You might have to pay some tax if you choose to exercise your stock options, details on that in the next section. Once you exercise your ESOPs, you are free to sell the shares to anyone (some conditions might apply depending on to whom you are selling the shares).
  4. Sell: When you sell the shares, you get actual money credited into your trading account, depending on the sale value. At this point also, you might have to pay some tax, which is explained in the next section.

Tax on ESOPs

During the complete life cycle of ESOPs from the grant of ESOPs to vesting to exercising the ESOPs to get actual shares to selling the shares, tax liability for the employee comes twice into the picture: At the time of exercising the Option to buy actual shares of the company and at the time of selling the shares. No tax needs to be paid at the time of Grant of ESOPs.

Tax at the time of exercising the ESOPs: At the time of exercising his option, the employee pays a pre-decided amount to get shares of a company whose fair market value is higher. This will be reported in your Form 16 as your income from Salary. Hence, the employee has to pay tax on the difference amount.
If the company is listed on one recognized stock exchange, the fair market value is determined by the closing price on the exercise date.
If the company is not listed on any recognized stock exchange, the fair market value is determined by the merchant banker of the company.

Taxable amount at the time of exercising the option = Fair market value on the exercise date - Exercise price
Tax rate applicable at the time of exercising the option: based on the employee's tax slab

Tax at the time of selling the shares: Once an employee exercises his ESOPs and buys the shares of a company, they are treated as normal shares. He has to pay the tax on the capital gain. Capital gain will be calculated as the difference of the price on the exercise date and the sale price. Depending on whether the shares were held by the employee for short term (less than 1 year) or long term (more than 1 year), tax will be applicable.

Taxable amount at the time of selling the shares = Sale price - fair market value on the exercise date
Tax rate applicable at the time of selling the shares can be derived by:
if (listed) {
        held for short term: 15%
        held for long term: 10% on the gains exceeding Rs 1L
} else {
        held for short term: based on the income tax slab of the shareholder
        held for long term: 20% after indexation

An example involving Employee Stock Options

Rachel works as a full time employee in Central perk, which gave her 40k ESOPs as a bonus. The details of her grant are as below:

Grant Date: April 1, 2018
Vesting date: 31 March 2020 (2 years from the grant date)
Exercise price: Rs 10 per share
Exercise period: 10 years

Since the vesting date for Rachel’s ESOPs was in March 2020, she is now eligible for purchasing the stocks of Central Perk at a price of just Rs 10 per share, irrespective of what the market price is. She has this option of purchasing shares at a price of Rs 10 per share anytime within a term of 10 years from vesting (March 31, 2030).

Now, suppose she falls in the 30% tax slab and exercises her option and buys those 40K shares today at the price of Rs 10 per share. For calculations, let us suppose the Fair market price of the shares of Central perk (listed on the stock exchanges) is Rs 60 per share. In this case, she will have to pay a tax on Rs 20L (total value of bought shares = Rs 24L, Total exercise price paid by Rachel = Rs 4L). Let us say that she sells 10k shares on June 20, 2021 (short term) at a price of Rs 70 per share, and sells 10k more shares at a price of Rs 75 per share on June 20, 2022 (long term). The total calculations would be as follows:

Total amount paid by Rachel to buy the shares = Rs 4L
Total tax which Rachel needs to pay (ignoring cess for simple calculation) = 30% of Rs 20L = 6L
Total short term capital gain = Rs 1L
Short term capital gain tax = Rs 15K
Total long term capital gain = 1.5L
Long term capital gain tax = 5K (capital gain exceeding 1L = 50K)


Many companies give ESOPs since they are a good way for them to save some cash in hand and pay a part of their employees salary. Most of the start-up companies give ESOPs to their employees instead of giving full salary in cash. If the company grows, it is a growth for the employee too since he would be able to buy shares by paying less than the market price. However, this turns out to be a costly move since the company might lose its value or worse, may shut down in the future.

Hope you liked the article. You can read SEBI Guidelines on ESOPs on this link. Still have any questions related to the article? Let me know in the comments below. If you have any doubts or questions regarding this article or any other topic in the website, you can reach out to me through the Contact Me section of the website.

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