ESOPs continue to be pre-dominantly concentrated in the ICE sector and participation from MCG  and FS sector has seen an increase over a period, as per the latest KPMG ESOP survey report titled ‘ESOP survey report 2021’.

KPMG in India, through its Employee Stock Option / Ownership Plan (ESOP) Surveys in 2011 and 2015, endeavored to present insights on leading industry practices, differentiators and trends based on its analysis of data collated from a range of organizations.

There has been increased activity in the ESOP domain both in India and globally since then. Considering the changing regulatory environment, we re-launched the survey to understand the current trends.

The ESOP Survey Report 2021 aims at guiding corporates and start-ups looking at establishing leading compensation practices, by providing them a preview to current trends and at the same time sharing insight on few relevant aspects from a tax, regulatory and accounting perspective. It is imperative to consider any sector specific regulation. The report also attempts to cover emerging global trends.

Parizad Sirwalla, Partner and Head – Global Mobility Services, Tax, KPMG in India said, “ The current market situation and economic disruption caused by the Covid-19 pandemic has led several companies to rethink their compensation strategy and align the same to long-term corporate growth.  In order to combat these unprecedented times, corporates around the globe are looking at ways and means to retain high performing employees and at the same time, being neutral from a cash flow perspective.  One such option is to introduce / continue with equity-based compensation which not only helps in retention but also helps organizations manage cash flows which can then be utilized to fund day-to-day business operations”.

ESOPs have been conventionally used as a compensation tool by Indian and multi-national companies. The survey indicates that companies consider ESOPs as an incentive tool which enhances productivity, motivates employees, creates sense of ownership amongst employees and thereby increases employees’ interest in the company’s overall performance. Many Indian companies with overseas operations are increasingly awarding equity incentives to attract and retain talent.

Out of the  respondent companies having active ESOPs or who were proposing roll-out of ESOPs, 83 percent stated that their plans were linked to equity shares and balance linked them to warrants, debentures and other securities. Indian companies continue to adopt conventional equity linked plans. They are yet to evolve plans which are linked to warrants / other securities that carry a lower risk of fluctuation as compared to equity shares.

A time-based vesting schedule of three to four years with annualised vesting is still prevalent. However, a sizeable portion of participants also indicated ‘cliff vesting’ i.e. vesting at the end of the specified period.

Considering the accounting impact, companies are generally averse to granting options at a discount.

ESOP benefits are taxable as perquisites (i.e. salary income) in the hands of the employees. The employer is required to comply with the routine salary related withholding tax obligations with respect to such perquisite.

The perquisite value is ascertained as a difference between the Fair Market Value (FMV) of the share on the date of exercise and the exercise price. There are specific valuation rules prescribed for listed and unlisted companies. The FMV of shares of a company not listed on Indian stock exchange needs to be determined by a Category I Merchant Banker registered with Securities and Exchange Board of India (SEBI).  Eligible start-ups are entitled to certain concessional tax provisions which allows deferment of the perquisite tax liability.

The incremental gain, if any (i.e. difference between sale consideration and the FMV on the date of exercise), on sale of shares would be considered as capital gains in the hands of employees. For the purpose of computing capital gains, FMV on the date of exercise becomes the cost base. The capital gains tax treatment also depends on the holding period and whether the shares are sold on a recognised stock exchange in India.

Where the shares are transferred by an employee pursuant to buy-back by an Indian domestic company, there is no tax in the hands of the employee. The company (both listed and unlisted) is liable to pay additional income tax on distributed income, on buyback of shares, as prescribed.

The current market situation and economic disruption caused by the Covid-19 pandemic has led several companies to rethink their compensation strategy and align the same to long-term corporate growth.  In order to combat these unprecedented times, corporates around the globe are looking at ways and means to retain high performing employees and at the same time, being neutral from a cash flow perspective.  One such option is to introduce / continue with equity-based compensation which not only helps in retention but also helps organizations manage cash flows which can then be utilized to fund day-to-day business operations.

“The recent trends of multi-fold deals of management buy-outs coupled with economic environment has been a driver for many companies (including start-ups) to consider ESOPs as a compensation strategy” added Parizad Sirwalla.