Employees’ Stock Option is a right but not an obligation granted to an employee in pursuance of Employees’ Stock Option Plan/Scheme (ESOP), to apply for shares of the company at a pre-determined price. ESOP is formulated with the intent to encourage ownership of a company’s equity by employees on an ongoing basis. This operates as an incentive for the employees, motivates them to give its best and enables the company to attract and retain the best available talent. It assists the company to improve its profits without disturbing its cash flow.

Options are usually granted at an option price determined by reference to the market value of the company’s shares. Stock options has four district stages which are Grant of options, Vesting of option, Exercise of options and ultimate sale of shares received on exercising an option.

Value of the Stocks allotted or transferred in pursuance of an option exercised by employees of a company free of cost or at concessional rate is the benefit in the nature of a perquisite. Earlier, Finance Act, 1999 inserted section 17(2)(iiia) applicable only for the assessment year 2000-01 which provided that the difference between the fair market value of the specified securities allotted on the date of exercise of option under ESOP and the price paid or payable by the employees for acquiring such securities would be treated as perquisites. Consequential amendment was made in section 49(2B) that in the event of transfer of such securities the difference between the fair market value on the date of exercise of the option and the actual sale price would be taxed as capital gains.

But, insertion of proviso to section 17(2)(iii) by the Finance Act, 2000 effective from the assessment year 2001-02 provided that value of any benefits provided free of cost or at a concessional rate to its employees by way of allotment of shares, debentures or warrants (Stocks) directly or indirectly under any ESOP formulated in accordance with the guidelines issued by the Central Government would not be treated as perquisites.

This means that any benefits of the stocks allotted to permanent employees and a director by the company would not be taxed as a perquisite if the shares are allotted under ESOP formulated in accordance with the guidelines issued by the Central Government.

Shares allotted after 1st April, 2000 under ESOP irrespective of the date of exercising the option by the employee, its value would not be treated as a perquisite. Even if the employee has exercised the option prior to 31st March, 2000, it would not be a taxable perquisite provided the shares are allotted after 1st April, 2000.

The employees stock option plan or scheme as notified by the Central Government vide Notification No. 323/2001[F.No. 142/48/2001-TPL] dated 11th October, 2001 in brief, is as under:

1. Employees stock option plan or scheme shall include:

   1. Employees stock purchase plan or Employees Stock Option Scheme wherein employee allows the employer to withhold a certain portion of his monthly salary, the accumulated amount of which is utilized to acquire shares at discounted value.

   2. Employees’ stock ownership plans whereby an employee of the company is given option to acquire shares at pre-determined price after certain period.

   3. Employees stock purchase scheme under which the company offers shares to an employee as a part of public issue or otherwise at a predetermined price.

   4. Employees stock option scheme under which a company grants option to its employees to buy a specified number of shares at a specified price during a specified period.

   5. Stock appreciation rights or plans under which the employees are awarded stock equivalents at a certain pre-determined value and after a certain minimum stipulated period, the employees are allowed to encash such rights.

2. Any such plan or scheme shall be incorporated in a written document and it shall specify various information such as number of shares issued under the scheme, class of employees entitled to the scheme, pricing formula, lock in period, basis of valuation of shares in case of unlisted company, restriction on non-transferability of shares etc.
   
3. Indian company issuing shares under the plan/scheme shall comply with regulations prescribed by SEBI or any other regulatory authority.
   
4. An employee who is a promoter or belongs to a promoter group or a director holding more than 10% of the outstanding equity shares either himself or through his relative or body corporate is not eligible to participate in the scheme.
   
5. Employees would mean a permanent employee and a director of a company whether whole time or not.

Stocks received under the ESOP, if sold by the employee, would attract tax on the capital gain arising on such transfer in the year of sale.

In the event of transfer of such stocks under a gift or an irrevocable trust, such transfer would attract tax by virtue of insertion of proviso to section 47(iii). Amendment to section 48 also provides that the market value of stocks on the date of such transfer would be considered as full value of consideration received or accruing as a result of transfer for the purpose of computing capital gain.

However, stocks received under the ESOP during the assessment year 2000-01 and are taxed as a perquisite, cost of acquisition would be the value adopted as a perquisite u/s. 17(2) of the Act for computing capital gain.