ESOPs stands for Employees Stock Option Plans. The plan offers employees the opportunity to own a piece of the company they work for. Now, just like dividends are a way for a company to share profits with its shareholders, ESOP buybacks are a way for a company to share profits with its employees. A buyback of ESOPs is when a company purchases its own shares from the existing shareholders.
In this topic, we will delve into the intricacies of ESOP buybacks, their tax implications and explore the factors you should consider when deciding whether or not to opt for this financial maneuver. By the end, you’ll have a clearer picture of the tax landscape and be better equipped to make informed decisions about your ESOPs.
What are the different types of ESOPs in India?
In India, there are primarily two types of ESOPs commonly offered by companies to their employees:
-
Incentive Stock Options (ISOs):
ISOs are also known as “Qualified Stock Options” or “Statutory Stock Options”. These options are typically offered to key employees, including executives, and are designed to provide them with a stake in the company’s long-term growth and success. -
Non-Qualified Stock Options (NSOs):
NSOs, also known as “Non-Statutory Stock Options,” are more commonly offered to a broader range of employees, including non-executives. Stock Appreciation Rights (SARs) are classified as Non-Qualified Stock Options.
What is a buyback?
There are three primary ways to provide liquidity in a stock option plan.
- IPO
- Acquisition
- Buy-back
A buyback happens when a company buys its own shares from the stock market. It’s similar to how dividends are a way for a company to share profits with its shareholders. When a company does a buyback, it’s like sharing profits with its employees through an ESOP. Buybacks can show investors that the company has enough cash for emergencies and a low risk of financial problems.
Is participating in buyback mandatory?
Buyback is completely optional. There can be various deciding factors to determine whether you should participate in the buyback or not. Some of the factors can be
- Future prospects of the company
- Need of liquidity in the short term
- Taxes on net earnings
What are SARs?
Stock appreciation rights (SARs) are a type of employee compensation linked to the company’s stock price during a predetermined period. SARs are profitable for employees when the company’s stock price rises.
The primary benefit of stock appreciation rights is that employees can receive proceeds from stock price increases without having to buy stock.
Let’s look into the tax impact here:
Taxes on SARs Buyback event?
- For Employees:
- Taxable Event: The taxation event for SARs occurs at the time when the SARs are settled in cash or stock.
- Tax Treatment: When SARs are exercised, the amount received is treated as a part of the employee’s salary and is subject to income tax at normal rate (Slab rate). The employer is required to withhold taxes on the amount and deposit them with the government.
- Treatment of Unexercised SARs: If the SARs expire without being exercised, they generally have no tax implications.
- For Employer:
The employer shall deduct tax at an applicable slab rate on the net earnings and pay the net amount to the employees.
For Example:
Mr. Kapoor holds 10,000 shares of XYZ Private Limited. Let’s say in FY 2023-24, XYZ pvt ltd offers a buyback of 60% of shares at a price of ₹200/- per share. The strike price (price at which shares are offered) was ₹10/- per share.
Let’s say, Mr. Kapoor accepts the offer.
Tax effect - Assuming Mr. Kapoor falls in the 30% tax bracket.
Net earnings = (Buyback price - strike price) * No of shares exercised
= (200-10)*10000
= ₹19,00,000/-
Tax withheld by company = 19,00,000 * 30%= ₹5,70,000
Net payout to Mr. Kapoor = ₹13,30,000/-
Hope this helps you understand the tax impact on SARs buyback.