Various types of Employee Benefit Stock Option Plans

Employee Stock Benefit Plans are structured compensation tools designed to reward and retain employees by offering them a stake in the company's success. These plans allow employees to either acquire actual company shares or benefit from the appreciation in share value over time.

Such plans are widely used by start ups, private companies, and listed corporations to align employee interests with long-term business goals by linking rewards to performance or tenure, they encourage loyalty, productivity, and ownership thinking among employees.

Typically, these plans go through stages such as grant, vesting, exercise or payout, and taxation. The benefit may be delivered in the form of equity (shares) or cash, depending on the plan's design.

This article explains six major types of employee stock benefit plans: ESOP, ESOS, ESPS, RSU, SARS, and Phantom Shares. Each plan is detailed below with elaborated features, benefits, taxation, and strategic relevance.

1. ESOP - Employee Stock Ownership Plan

An ESOP is a structured plan in which companies create a trust that holds shares for employees. Over time, based on their years of service or performance+, employees receive allocations of these shares. Employees don't need to pay anything for these shares, making it a valuable tool for long-term wealth creation.

Key Features:

• Trust-based share allocation: Shares are placed in an employee benefit trust and gradually allocated.
• Vesting schedule: Shares vest based on service period or performance targets.
• No purchase needed: Employees receive shares without paying.
• Full ownership: Once shares are vested and allocated, employees become shareholders.
• Payout in equity: Benefits are provided in the form of actual company shares.

Benefits:

• Empowers employees with ownership, encouraging a sense of loyalty.
• Aids in building long-term retirement wealth.
• Lowers attrition in mature companies aiming to build employee engagement.

Taxation:

• Perquisite tax may be levied when shares are transferred.
• Capital gains tax applies when employees sell the shares in the future.

2. ESOS - Employee Stock Option Scheme

Under an ESOS, companies grant employees the right (but not the obligation) to buy company shares at a fixed price, after a vesting period. This model motivates employees to help increase company value since they benefit if the share price rises.

Key Features:

• Options granted, not shares: Employees receive rights to purchase shares later.
• Vesting requirements: Typically tied to continued service or performance milestones.
• Exercise price set at grant: Often equals the market price on the grant date.
• Defined exercise period: Employees must exercise options within a set timeframe after vesting.
• Ownership post-exercise: Employees only become shareholders after exercising options.

Benefits:

• Offers potential for significant financial gain if the share price appreciates.
• Allows employees to decide when and whether to invest.
• Preferred by startups and high-growth firms with limited cash but high potential.

Taxation:

• Perquisite tax applies at the time of exercise (difference between market price and exercise price).
• Capital gains tax applies when the employee later sells the shares.

3. ESPS - Employee Stock Purchase Scheme

ESPS allows employees to buy shares directly, usually at a discounted price, often through payroll deductions. It enables employees to invest in the company at favourable terms.

Key Features:

• Direct share purchase: Employees buy shares voluntarily, often through salary deductions.
• Discounted price: Offered at 5-15% below market value.
• Immediate ownership: No vesting or exercise; ownership begins upon purchase.
• Frequent offering windows: Typically aligned with financial quarters or annual periods.

Benefits:

• Promotes employee involvement and financial participation.
• Enables wealth-building through discounted equity ownership.
• Useful for listed companies aiming to broaden shareholder base among staff.

Taxation:

• Perquisite tax on the discount received at the time of purchase.
• Capital gains tax applies when the shares are sold later.

4. RSU - Restricted Stock Units

RSUs are a form of deferred compensation where employees receive shares after meeting specific conditions. Unlike options, there is no cost to employees; shares are awarded automatically upon vesting.

Key Features:

• Promise of future shares: Shares are awarded after certain milestones.
• Time or performance-based vesting: Vesting may depend on tenure or reaching KPIs.
• No purchase or exercise required: Shares are issued automatically upon vesting.
• Ownership on vesting: Employees become shareholders when shares are transferred.

Benefits:

• Provides guaranteed value to employees, unlike options which can become worthless.
• No risk of upfront investment.
• Encourages long-term retention and performance.
• Often used by established firms, including tech companies and MNCs.

Taxation:

• Perquisite tax on fair market value at the time of vesting.
• Capital gains tax upon eventual sale of shares.

5. SARS - Stock Appreciation Rights

SARS allow employees to benefit from the appreciation in company stock without owning the actual shares. The gain is paid in cash or shares, depending on the plan structure.

Key Features:

• Gain-based compensation: Employees receive the increase in stock value.
• No actual share issuance (unless chosen): Minimizes equity dilution.
• Vesting based on performance or tenure: Similar to other plans.
• Cash or share settlement: Payout method is flexible.

Benefits:

• Encourages performance without requiring share purchase.
• Avoids upfront investment by employees.
• Effective for firms wanting to limit share dilution.

Taxation:

• Entire gain is taxed as salary income when paid.

6. Phantom Shares

Phantom shares are notional units that track the company's stock value. Employees do not get real shares but receive a cash bonus equal to the share value or its increase over time.

Key Features:

• No real shares issued: Only virtual tracking of stock price.
• Cash payout: Based on value at vesting or at a liquidity event.
• Vesting rules apply: Similar to RSUs and SARS.
• Customizable terms: Plan structure varies by company.

Benefits:

• Delivers performance-based rewards without giving up equity.
• Easy to administer, especially for private companies.
• Suitable for senior executives or firms averse to dilution.

Taxation:

• Entire payout is taxed as salary income.
• No capital gains tax, since shares are not actually sold.

Conclusion: Choosing the Right Plan

Each employee stock benefit plan offers distinct advantages and is suited to different company types and goals.

By company stage:

• Startups: ESOS and RSUs are ideal due to growth potential and limited cash.
• Mature companies: ESOP and ESPS help foster ownership and reward loyalty.
• Private/family businesses: SARS and Phantom Shares provide performance rewards without share dilution.

By taxation and cash flow impact:

• RSUs, SARS, Phantom: Taxed as salary; may need cash reserves.
• ESOS, ESPS: Dual taxation (perquisite + capital gains); lower immediate cash outflow.

Strategic use:

• ESOP for junior-level retention
• RSUs for mid-level long-term stability
• Phantom Shares or SARS for senior leadership with performance-based incentives

Ultimately, companies may adopt a combination of these plans to align employee motivation with long-term value creation, while balancing compliance, cost, and culture.

Below is the comprehensive bifurcation of the various types of Employee Stock Benefit Plans in a detailed table format for clear understanding and comparison.

Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement.