Understand ESOP & RSU.

An ESOP, short for Employee Stock Option Plan, and an RSU, short for Restricted Stock Unit, are forms of compensation provided to employees in exchange for their services rendered to an organization. These schemes also grant the employee ownership in the organization they work for. ESOPs and RSUs are typically granted at a discounted rate to employees, with the differential amount between the exercise price and the fair market value (FMV) being borne by the organization. After the grant of an ESOP or RSU, a certain vesting period is required before the employee can exercise their options. It is important to note that these options can only be exercised if the employee remains on the organization's payroll during the vesting period.  

Following are the key considerations for accounting of ESOP & RSU.

Ø  The difference between the exercise price and the FMV is accounted as employee stock compensation cost over the vesting period.   

Ø  There are various option pricing models such as:

•       Binomial Pricing Model

•       Black Scholes – Merton Formula

Ø  Whilst Ind AS 102 on Share-based Payments does not obligate any method, the option-pricing model used must consider a minimum of six inputs, viz.

•       Exercise price of the option

•       Life of the Option

•       Current price of the underlying share

•       Expected volatility of the price of the underlying share

•       Expected dividends on the underlying share

•       Risk-free interest rate for the life of the options

Ø  On exercise of ESOP’s the exercise price is recovered from the employee

 

Ø  In case the employee’s don’t exercise the ESOP’s, then the employee stock compensation cost accounted for is reversed in the books of accounts.

Following is the important points from tax side required to be considered by the employer who is issuing ESOP & RSU.

Ø  The employee stock compensation cost is an allowable expense in the hands of the employer/ organization over the vesting period i.e. It is an allowable expense as and when it is accounted for as the expense fulfills the followings conditions

ü  It is a Business Expenditure

ü  It is incurred during the year.

ü  It is not in the nature of Capital Expenditure/ Personal Expenditure

ü  It is not prohibited by law.

ü  The expenditure is not contingent in nature.

Ø  As per section 145(1) of the Income Tax Act, the PBT should be computed considering Accounting standard and hence once  in PBT, ESOP expenses is allowed as deduction considering accounting standard, then same cannot be further add back in the tax computation. Further, there is no adjustment proposed anywhere in Income Tax Act or Income Computation & Disclosure Standards.

 

Ø  Further, when ESOP is taxable in the hands of employee as salary income, then same should be allowed as salary expenditure in the hands of employer.

 

Ø  The above conditions are mentioned in the decision of the Special Bench in the case of Biocon Ltd, which has been Acepted by the Karnataka High Court.