ESOP is a measure to strike a chord with the good employees (Permanent Employees and Whole-time Directors) by offering them with company’s equity shares or stock option, and at the same time making them to stay with the company for some more years by providing them the right to exercise the share subscription in future. Nowadays, ESOPs are widely used as tools for creating wealth for employees as also motivating them to continue working for the Company. This also helps cash crunched company by warding off the immediate payment of bonus/ other benefits.

Here is a simple example to understand ESOP:

X Co. Ltd Has its share capital dividend into equity shares of Rs. 10 each. On 1.4.2012 it granted 20,000 employees stock option at Rs. 50 per share, when the market price was Rs. 120 per share on a condition that employees stay upto 31.03.2014. The options were to be exercised between 01st April, 2014 and 30th April, 2014. The employees exercised their options for 16,000 shares only and the remaining options lapsed. The company closes its books on 31st march every year.

Vesting period is the period that an Employee needs to wait or keep working in the company. In the above example it is period between 01.04.2012 to 31.03.2014.

Exercise period is the period when employee can exercise the plan. But he has to pay the exercise amount otherwise the employee shall not be allowed to participate until the company again allows the employee to exercise the plan. At allotment, if the market price of share is high enough then it’s worth waiting otherwise it’s not that worth waiting. In the above case, if market price is more than Rs. 50, then only the employee will exercise the option.

Why the Scheme of ESOP?

  • Attracting and retaining the best employees.
  • Increase performance, trust and sense of ownership among employees.
  • Companies on high growth trajectory can introduce this scheme to let key employees continue their stay.
  • The companies with shortage of cash can simply adopt ESOP model.

ESOP from the view of Taxation (For an Employee)

At the time of receiving ESOP

  • Benefit arising from ESOP – taxed as perquisite in the hands of Employee
  • Calculation : Fair Market Value on date of exercise – Exercise Price
  • Employer is required to deduct TDS in respect of such perquisite u/s 192.

At the time of Sale of Shares;

  • Treated as Capital Gain, FMV on exercise date is treated as cost of acquisition.
  • Calculation : Sale Price – FMV @ Exercise date
  • Long Term Capital Gain(LTCG) on Unlisted Shares – taxed @ 20% with indexation
  • Short Term Capital Gain(STCG) on Unlisted Shares– taxed @ applicable slab rate
  • LTCG through recognised stock exchange – Upto Rs. 1 lakh exempt, excess amount taxed @ 10% without indexation
  • STCG through recognised stock exchange – taxed @ 15%

For further details refer, Tax Implications – Securities.

ESOP from the View of Accounting:

Expense in Books is recognised based on the difference between the FV on the date of offer & exercise price over the vesting period. Any difference arises due to the non-exercising will be transferred to general reserve. Such expense is allowed in the income tax to the extent exercised only when shares were actually. In the intervening period temporary tax difference arises which leads to creation of Deferred Tax Asset.

Entries in Records:


Dr. Profit and Loss A/c

7,00,000/- [20,000*(120-50)*1]/2

Cr. Employee Stock Option A/c


(Being Employee Stock Option Recorded)


Dr. Profit and Loss A/c

7,00,000/- [20,000*(120-50)-700000]

Cr. Employee Stock Option A/c


(Being Employee Stock Option Recorded)



Dr. Bank A/c


8,00,000/- 16000*50

Cr. To Employee Stock Option A/c


(Being Amount Received)


Dr. Employee Stock Option A/c 19,20,000/- 16000*120

Cr. Equity Share Capital A/c

1,60,000/- 16000*10

Cr. Equity Share Premium A/c

17,60,000/- 16000*110

(Being Share Allotted)


Dr. Employee Stock Option A/c

2,80,000/- 4000*70

Cr. General Reserve A/c


(Being ESOP Cancelled)