ESPP, ESOP and RSU are benefits granted to individuals during their first job. The benefits are included in their CTC package, but most employees find it hard to understand these benefits and often confuse them with each other. Following is an explanation of each benefit and the tax implications associated with them.
What are Restricted Stock Units (RSU)?
Restricted Stock Units can be understood fairly easily. An employee receives company stock from the company where he / she plies her trade subject to the involvement of a vesting period. A vesting period is basically the duration for which the employee must wait to claim the shares allotted by the company. So for instance, if a company offers its employee 200 RSUs vesting in two years, it means that the employee will be eligible to claim 200 shares from the company after he / she has completed two years with the company.
RSUs have been identified as a great means for companies to reward their employees, like WIPRO, who rewarded 4.5 million RSUs to 1200 of its top management employees. RSUs are also a relatively good means for an employer to ensure that their employees stick with them for the long term. For instance, if a company is granting 500 RSUs vesting in three years, the employee will have to remain with the company for the following three years to claim the benefit, thus making him / her reconsider changing jobs.
Companies sometimes grant RSUs to their employees in a phased manner, such as 25% RSU every year. In case a company is granting 200 RSUs with a condition of 25% RSU vesting every year, then 25% (50 shares) can be claimed at the end of the first year. Another 25% or 50 shares can then be claimed in the second year, and only at the end of the fourth year will an employee receive all 200 shares.
Employee Stock Options (ESOP)
Employee Stock Options are usually offered to employees of the biggest organisations in India, particularly IT companies that are listed outside the country. An individual with a stock option is one who has the right to purchase a stock at a future date and at a predetermined price decided at the time the individual took those stock options. Basically the future market price of a stock does not matter and the individual will always have the option to purchase the stock at the predetermined price. However, in case the current market price of the stock is lower than the predetermined price, then the customer can opt to not exercise the stock option.
For instance, if an individual joins a company on the 1st of January, 2015, and receives 500 ESOPs with a three-year vesting period from the company and the vesting price is set at Rs.200, the vesting date will be the 1st of January, 2018 and on that particular date, the individual will have the option to purchase 500 stocks of the company for Rs.200 each. However, in case the price of the stock has increased to Rs.500, the individual can exercise the option made available to him and purchase 500 stocks for Rs.200 each, thus making a profit of Rs.300 on each stock. In total, the individual makes a profit of Rs.1,50,000 by simply exercising his option to purchase at the vesting price.
Now, in case the value of a stock reduces from Rs.200 to Rs.150, the individual does not necessarily have to exercise his / her option to purchase stock for Rs.200 per stock as doing so will result in a loss of Rs.50 per share. Instead, he / she can wait for prices to rise again and then exercise their option to purchase for a potential profit.
Employee Share Purchase Plan (ESPP)
Employee Share Purchase Plan is another benefit provided by employers to their employees to buy the company’s stock at a discounted value. In this kind of plan, the employee is required to contribute a small portion of his / her salary towards the scheme every month. The employee is free to choose the part of his / her salary that they wish to contribute towards the plan. The portion of the salary contributed by most employees usually ranges between 1% and 15% of their monthly salary. The money contributed towards the plan accumulates over a few months before the employee decides to purchase stock from the company at a discounted price. The ESPP will determine the discount the employee will receive. However, it is usually the minimum price at the start and end of the ESPP. For instance, if a company offers an ESPP that can be opted for twice in a year, there are two windows – January to June and July to December. The company must be informed beforehand by the employee regarding the amount of money they would like to contribute on a monthly basis. In case the employee opts to contribute 10% towards ESPP, then 10% of their salary will be deducted and the remaining will be given to the employee in hand. Suppose an individual opts the January to June window and contributes Rs.8,000 towards ESPP, then he / she will collect Rs.48,000 over six months and will receive the shares at the end of the plan.
If the price of the stock was Rs.100 at the beginning of January and the price of the stock increased by Rs.20 to Rs.120 then the stock price for purchase by the employee will be the minimum of Rs.100 and Rs120, which is Rs.100. The employee will receive an additional discount of 15% and the final price he / she pays for the stock will be only Rs.85. However, there may be situations wherein companies only consider the starting price or the ending price, so individuals are encouraged to read their particular company’s EPSS plan in detail.
Taxation on ESPP, ESOP and RSU
The rules that govern the taxation of ESPP, ESOP, and RSUs are the same as they all deal with stocks that an employee receives and the taxation rules are also fairly easy to understand. In fact, there are only two rules, viz. taxes to be paid in India, and stocks listed on foreign exchanges.
For Taxes to be paid in India
When an employee sells their ESPP, ESOP or RSU once the vesting period is complete and receive their money, it is their duty to pay tax on that amount in India. The nature of the gains will determine the amount of tax the employee will have to pay. In case the shares are sold with a year of acquiring them, the gains resulting from such a sale are known as Short Term Capital Gains, and shares sold after a year of acquiring them are known as Long Term Capital Gains.
Short Term Capital Gains will be charged at 15% and no tax will be applicable on Long Term Capital Gains if shares are listed on Indian stock exchanges. In case the shares are not listed on Indian stock exchanges, profits will be viewed as the employee’s income and taxed depending upon the tax slab for Short Term Capital Gains, and 20% with indexation will be charged on Long Term Capital Gains.
For Stocks listed on Foreign Stock Exchanges
When an employee sells his / her ESPPs, ESOPs or RSUs, he / she will receive only a limited number of units after tax, and when the employee takes the funds in India, they may also have to make additional tax payments on the income again in case the double tax treaty is not available in that particular country.