Glossary
ESOP
Employee Stock Option Plan — a program that gives employees the right to buy company shares at a predetermined price, as a form of compensation.
By Amit Tyagi, Fitoor Capital · AletheiaAI Glossary
Definition
ESOPs (Employee Stock Options) give employees the right to purchase company shares at a predetermined price (the "exercise price" or "strike price") after a vesting period. They align employee incentives with company success — if the company grows and the share value increases above the exercise price, employees can profit from the difference.
ESOP mechanics: an employee is granted options (not shares). After vesting, they can exercise — pay the exercise price and receive shares. The profit is: current share value − exercise price × number of options exercised. Options that are "underwater" (strike price > current value) have no intrinsic value.
Indian Companies Act allows private companies to create ESOP schemes with board approval, shareholder approval, and a formal plan document.
India Context
Indian ESOP tax treatment has improved significantly. Tax on ESOP is deferred to exercise (not grant or vesting for unlisted companies). At exercise: taxed as perquisite (income tax at slab rate) on the difference between FMV at exercise and exercise price. At sale: capital gains tax — LTCG if held >24 months (20% with indexation for unlisted), STCG if shorter.
Indian DPIIT-registered startups get an additional benefit: deferral of perquisite tax for 5 years from exercise date or until sale of shares, whichever earlier. This makes ESOPs materially more attractive for employees of DPIIT-registered startups.
Example
An employee at a DPIIT startup is granted 10,000 options at ₹10/share exercise price. 4 years later, options vest. Company's FMV is ₹200/share. She exercises all 10,000 options: pays ₹1 lakh (10,000 × ₹10), receives shares worth ₹20 lakh. Taxable perquisite = ₹19 lakh (FMV minus exercise price). Under DPIIT tax deferral, this tax is deferred to actual sale — she pays tax when she sells shares, not at exercise.
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