ESPP – Employee Stock Purchase Plan
What is ESPP?
ESPP is a tax-efficient way through which employees have the opportunity to purchase stocks of the company they work for at a discounted price. Employees contribute to the plan by way of payroll deductions. These deductions build up between the offer date and the purchase date.
How does ESPP work?
ESPP works like a SIP (Systematic Investment Plan) where employees contribute a part of their salary (say 5 -15%) for a fixed time. Once the period is over and the corpus is accumulated, it can be utilized to purchase the company’s stock. On the purchase date, the company uses the accumulated funds to purchase stocks on behalf of participating employees.
The amount of discount depends on the plan. For example, it maybe 15% lower than the market price. For listed or publicly traded stocks, the general practice is to consider the prevailing price as base price, either at the beginning or at the end of the ESPP period, whichever is lower.
The applicable discount rate is applied at this base price. If the price of the stock at the start of the period is Rs 100 and at the end is Rs.80, then the base price should be taken to be Rs 80. A discount of 10% on the base price should mean that the employee can procure the stocks at the rate of Rs.72 per stock.
Also read about – What are ESOPs?
Key ESPP Features
The following key features of the ESPP ensure that the employee always receives the best possible purchase price:
Look-back feature
Depending on the plan, the employee may be able to purchase stock for up to 15% less than the market price. For example, if the company’s stock is trading for INR 50 at the time of purchase, the person may only have to pay INR 42.50 per share.
Reset feature
If the company’s share price at the beginning of the second purchase period is lower than the price on the offering date, the reset feature kicks in. In this case, the discount is calculated as the lower of the closing price on the first day of the abbreviated offering period or the closing price on the purchase date.
Taxability of ESPP
There are two stages of tax incidence on ESPP – first occurs at the time of allotment of shares, and second, happens when the employee sells the shares.
At the time of allotment of shares
When shares are allotted, the discount that the employer has given the employee is counted as a “perquisite” and is taxed as “Income from Salaries”. Or in other words Perquisite in the hands of Employee is equal to Fair Market Value minus the Actual Amount paid. In the case of a listed company, Fair Market Value is the average of opening and closing price on the date of Allotment. In the case of unlisted company Fair Market Value is the value determined by the Merchant Banker.
When the employee sells shares
The second stage is when the employee sells the shares. At that time, the gain will be taxed as capital gains STCG or LTCG based on the holding period.
For Listed stocks, short term capital gain (STCG) of 15% is applicable for holding periods of less than one year. And if the holding period is one year or more long term capital gain (LTCG) tax of 10% is applicable.
For Unlisted Stocks, short term capital gain (STCG) is taxable at tax slab rates of the individual for holding periods of less than one year. And if the holding period is one year or more long term capital gain (LTCG) tax of 20% is applicable. Please get in touch with your tax advisor for more details.
Also read about – What are Restricted Stock Units (RSUs)?
Advantages
- Sale of shares at a higher price
The ESPP lets the employee buy shares at a discount – this is quite an advantage! If the employee holds shares and the company’s share price goes up, it is a win-win situation for the employee because he/she can sell the shares at a higher price.
2. Long term and Short-term goals
The ESPP is a great way to strengthen one’s savings strategy, too. ESPP can be considered for all of short- and long-term savings goals mainly:
- To pay off high-interest debt
- To supplement the retirement savings.
- To save money for a new house down payment.
- To create or contribute to a college education of children.
- To build an emergency savings fund.
3. Employee Stake
With this type of program, employees will have a stake in the company that they are working in. This in turn gives employees an incentive to work harder and help their businesses succeed. They know that if the company does well, the price of the stock can go up significantly. And in this way, they can reap a substantial benefit from owning stock in the company.
Limitations
Most stock plans seem safe to participate in if one can sell the stock immediately or close to it. However, it is probably a bad idea to hold on to the company stock for a significant amount of time. In the process, the person has a significant amount of exposure to the risk of losing a good chunk of hard-earned money.
