A plan established by a company whereby a certain number of shares are reserved for purchase and issuance to key employees. Such shares usually vest over a certain period of time to serve as an incentive for employees to build long term value for the company. Employee ownership occurs when a corporation is owned in whole or in part by its employees. Employees are usually given a share of the corporation after a certain length of employment or they can buy shares at any time. Employee-owned corporations often adopt profit sharing where the profits of the corporation are shared with the employees. Another formal arrangement for employee participation is called Employee Stock Ownership Plans (ESOPs).
Employee ownership appears to increase production and profitability, and improve employees' dedication and sense of ownership.
History
The employee stock ownership plan (ESOP) concept was developed in the 1950s by lawyer and investment banker Louis Kelso, who argued that the capitalist system would be stronger if all workers, not just a few stockholders, could share in owning capital-producing assets.
In 1973, Kelso convinced Senator Russell Long, chairman of the tax-writing Senate Finance Committee, that tax benefits for ESOPs should be permitted and encouraged under employee benefit law. Soon, federal legislation promoting ESOPs appeared, most importantly the Employee Retirement Income Security Act of 1974 (ERISA), which governs employee benefit plans and established a statutory framework for ESOPs. In the following years, the number of ESOPs expanded dramatically now that sharing ownership was in the economic self-interest of company owners. From time to time since then, Congress has modified the laws governing ESOPs, most notably in the Tax Reform Acts of 1984 and 1986, the Small Business Job Protection Act of 1996, the Taxpayer Relief Act of 1997, and the Economic Growth and Tax Relief Reconciliation Act of 2001.
Types
A Company Share Option Plan allows companies to grant employees options to buy shares. These options cannot be granted at any discount to the prevailing market value and there are rules governing the timing of the exercise of these options if income tax is to be avoided.
Approved Profit Sharing allows companies to make tax-deductible payments to a trust which buys shares in the company and hands them out later to employees. As long as the shares are held in trust for three years, the employee pays no income tax on the value of the free shares, though capital gains tax is payable when the shares are sold.
Save As You Earn (SAYE) Sharesave requires employees to save between £5 and £250 per month out of their post tax pay. From the outset, they are awarded options on the company shares at a discount of up to 20 per cent of the then market value. In the meantime, the employee benefit trust borrows money to buy shares. Employers tend to like this scheme because participants are asked to show commitment to their company by signing regular savings contracts of three, five or seven years.
Enterprise management Incentives were brought into being by the Finance Act 2000. EMI involves new tax-shielded share options, which can be granted over shares with an initial market value of up to £100,000. To qualify for EMI a company must have gross assets of less than £15m and must be an independent trading company. A maximum of 15 key employees per company can be incentivised in this way.
The All-Employee Share Ownership Plan is designed partly to encourage long-term employee ownership, and hence savings. It permit the award of free shares to all or certain employees on the grounds of their productivity. The employer can set a qualifying period of up to one year to enable key employees to participate.
Many companies operate more than one type of employee share scheme simultaneously.
Accounting of ESOPS in India
Under the Indian Income Tax Act, shares alloted to an employee under Government approved ESOP plan is not considered a perquisite. However, Fringe Benefit Tax is applicable on the ESOP shares. Recent changes to the law however, maintain, that companies can recover the amount of FBT paid for ESOP from its employees.
Employees will have to pay capital gains tax on the proceeds of the sale - if the shares are sold within one year of allotment. However, any proceeds on sale after a one year period is completely tax free (if transacted via a recognized stock exchange) under section 10(38) of the IT Act.
Employee Stock Ownership Plan (ESOP) is an employee benefit plan. The scheme provides employees the ownership of stocks in the company. It is one of the profit sharing plans. Employers have the benefit to use the ESOPs as a tool to fetch loans from a financial institute. It also provides for tax benefits to the employers.
Organizations strategically plan the ESOPs and make arrangements for the purpose. They make annual contributions in a special trust set up for ESOPs. An employee is eligible for the ESOPs only after he/she has completed 1000 hours within a year of service. After completing 10 years of service in an organization or reaching the age of 55, an employee should be given the opportunity to diversify his/her share up to 25% of the total value of ESOPs. Law has also provided an amendment for the employees who have attained the age of 60 and their ESOP shares are allotted after December 31, 1986. The amendment provides those employees with an option to diversify their shares up to 50%.
Individual employees’ accounts are credited with the stocks acquired by ESOP. They can also acquire stocks through stock options. Stock options provide employees the right to buy shares at a definite price* for a defined number of years in future.