Employee Stock Options, also known as ESOPS, is a part of the shares which are provided by the company to the employees. The employees who subscribe to shares would get advantages of selling the shares back to the company. This option is according to the will of employees. A company cannot redeem the stocks that are given to employees under the ESOP plan. ESOP plan is like a compensation that is offered to employees for their determination and motivation towards the development of the resources of the company. Employees are considered as the stakeholders of the company. These stakeholders are given the option to subscribe to the stock of the company. This would be offered as a package to the employees. Either a multinational or corporation would offer this ESOP package as an overall remuneration package to the employee. Apart from this, multinationals would also provide this to employees as they are promoted. Therefore ESOP is considered a contractual right for an employee to acquire shares of the company where they are working. ESOPS are also given to an employee who is working under a subsidiary of a foreign holding company. The foreign holding company/ parent company would offer these stock options to the employees at a predetermined rate. This rate would be compared to the market rate at which the stock option is issued. As the foreign holding company issues these shares, there would be several compliances related to FEMA. Therefore a company or subsidiary company has to ensure that employee stock options under FEMA are complied with before offering the shares to employees. When a foreign company provides employees of an Indian Company, such options, then compliance related to employee stock option under FEMA has to be followed. Companies have recently accepted ESOPs for improving the performance and productivity of an employee. Previously the system of ESOPs was used and considered primarily by knowledge-based companies. These would include software and companies that were engaged in biotechnology products. However, this trend has changed and is accepted by a vast spectrum of companies across the world. A foreign company would not need to offer a high salaried package to an Indian Employee but can benefit by offering an ESOP option to the employee. However, if the foreign company is choosing this option, then employee stock options under FEMA regulations have to be mandatorily complied with. Main Reasons for Providing ESOPs- Employee Stock Options under FEMA Employee stock options under FEMA, which are issued by the foreign holding company, are provided for the main reasons: Employee Motivation- When stock options are given to employees, a sense of being part of the organization is felt by them. This would indirectly make them perform better.Wealth Creation- Another reason for issuing stock options to employees is for creating more wealth. Stock options given to employees can be sold at a specified rate. With this rate, employees can subscribe to purchase more stock options. This would create a maximization of wealth in the long run.Creation of Interest in the Company- ESOPs are considered as contractual rights between the employer and the employee; still, these rights can be exercised at any point. However, these rights are not considered as obligations that an employee has to purchase shares at a predetermined price. This option is merely an interest that is created for the employee.Potential Commitment- Many companies issue stock options to employees, where the stock option would be active only after a particular period. This would directly affect the commitment of the employee in the organization.Beneficial for a Foreign Holding Company- A foreign holding company offering employee stock options under FEMA would not need to offer high salary packages to top executives in India. Instead, they would offer a remuneration package with available employee stock options, which can be utilized by the employee. Some multinationals offering large remuneration packages such as Google use this method.Tax Contributions- Companies that offer ESOPs are allowed to consider various tax deductions available to them. Any form of contributions to the ESOP is considered as deductible for tax.Period of Vesting of Shares- When companies provide employee stock options under FEMA and SEBI, there are certain compliances to be followed. The vesting period is the period in which the employee has a right to have an interest in the shares. This typically means an agreement or contract is created between the company and the employee. Companies determine vesting periods. However, if a company is listed with the SEBI, then the vesting period is one year. When the period is complete, the employee has the option to sell the shares.Companies can form a trust to consider ESOP- When employee stock options are provided, companies can incorporate a trust body for ESOP. The possibilities of offering ESOPs can be given to the trust. The trusts can take the responsibility of providing ESOPs in accordance to the rules. Companies, therefore, use Employee Stock Options. However, there has to be compliance for employee stock options under FEMA, Companies Act, RBI and SEBI regulations. If such rules are complied with, a company can issue a stock option without any difficulties. Framework for Employee Stock Options- Employee Stock Options under FEMA and other Laws The primary framework for an ESOP is the Companies Act 2013. When a company wants to issue ESOP, then it has to comply with the provisions of the Companies act 2013. Both listed and unlisted companies can issue ESOPs. However, if the company is listed in a stock exchange, then it would have to follow the regulations as per the SEBI ESOP regulations. Apart from this, for ESOPs to not attract any form of tax, they have to be compliant with the provisions of the Income Tax Act 1961. There are specific guidelines which are issued by the government concerning ESOPs under section 17(2) (iii) of the Income Tax Act 1961. Therefore a listed company would have to comply with the above two regulations related to issuing of ESOPS. When it comes to unlisted entities, the SEBI and Income Tax regulations will not apply to ESOPS. However, the Unlisted Companies (Preferential Allotment) Rules would apply to unlisted companies that want to issue ESOPs. Apart from this, the Income Tax rules would also apply to ESOPs. For a private company, the only regulation that governs the provisions related to employee stock options is the Income Tax Guidelines. A company planning to offer Esops to employees in the future has to comply with the rules. If a company wants to go for an Initial Public Offering (IPO), then it would be beneficial for the company to comply with the SEBI guidelines related to ESOPS. After the IPO, the company can issue ESOPs as per the pre-IPO SEBI ESOP Guidelines. By considering the above, a company would be compliant with the securities regulator. ESOPs issued in such instances would be valid. Under the Companies Act 2013, a special resolution has to be passed by the shareholders and management under section 81 to issue ESOPS. When a special resolution is passed on the issuance of ESOPs, then a statement has to be circulated to the other shareholders. Section 77 of the Companies Act does not permit any public company to issue any shares to its holding company or subsidiary company. This would be considered as a mode of providing financial assistance, which is not allowed. Apart from the above rules, employee stock options under FEMA compliance have to be also followed. Compliance -Employee Stock Options under FEMA Apart from compliance under SEBI, Companies Act and Income Tax Act, employee stock options under FEMA law also have to be complied with. The Reserve Bank of India (RBI) has issued various notifications related to employee stock options under FEMA compliance. One of the first notifications associated with employee stock options under FEMA was released on 05 April 2006. This notification was addressed to all banks dealing with Foreign Exchange Regulations. This notification specified the requirement of the issue of shares by a foreign company. The foreign company could allot these shares under the ESOP Scheme. The shares could be repurchased from employees through the automatic route. Under the Automatic Route for employee stock options under FEMA, there is no requirement to take government approval before going ahead with a particular transaction. This notifications and amendments would apply to Regulation 22 of the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) (Amendment) Regulation, 2004 (“Regulation”). Read Also: ESOP: A Tool to Hold on the Employees. What is regulation 22(2) of the regulation? This regulation applies to transactions that involve employee stock options under FEMA. Employees are allowed to purchase shares from a foreign holding company under this regulation. There is no form of monetary limit on the amount of money that can be transferred for the purchase of shares. This would be applicable for shares which are allotted as per the ESOP scheme of the company. The resident Indian would have to work in the branch office or the liaison office of the foreign company. The employee has to be termed as a regular employee or an executive director of the company, in which the foreign company has a significant amount of control. The amount of control will depend if the foreign company has more than 51%.Authorized dealers based on the above rules are permitted to allow ESOP transfers. If shares are offered by the same company or either through a special purpose vehicle, then it would be considered as employee stock options under FEMA if the following conditions are satisfied: The foreign company holds 51 %;The company which has a majority stake in the Indian Company or Branch office should be offering shares;Shares offered by the foreign company must be according to Internationally accepted standards and follow methods of uniformity; andThe annual report has to be submitted by the Indian subsidiary to the RBI. This would be submitted through the Authorised Dealer to the RBI. Following the above conditions, the foreign company or holding company would be allowed to issue shares to the employees in the Indian subsidiary. The foreign company would not have to wait for the approval process from the foreign company to grant the ESOP. As long as the above conditions are satisfied by the Foreign Company, an employee stock option under FEMA can be granted. In the same notification, the RBI allowed foreign companies to purchase employee stock options under FEMA. These shares could be repurchased by foreign companies as long as the following conditions were satisfied: The shares which are issued to employees under the scheme have to be under the rules related to FEMA.When the shares are repurchased back by the Foreign Company, they have to be under the norms of the initial offer.Annual returns have to be submitted according to the prescribed format to the RBI. The yearly returns have to be sent via the authorized banks.The repurchase option should be only through the automatic route. Previously the amendment which was made by the RBI regarding ESOP in 2004 seems to be similar. However, more conditions regarding the use of employee stock options under FEMA are mandatory according to the recent amendment. Regulatory Framework for ESOPs issued to Non-resident Indians Under the 2010 framework related to Foreign Direct Investment, a listed company can use the option to issue shares under the framework to employees in India or its employees in its wholly-owned subsidiary abroad. The employees must be resident Indian. This would not apply to the citizens of Bangladesh. These ESOPs can be issued through the form of trust with the following conditions: The SEBI regulates the scheme of issue of shares.Face values of the shares which are issued to Non-resident Indians do not exceed more than 5% of the paid-up capital.The issue of shares must be reported to the RBI within 30 days of the date of issue. Reporting of ESOPs which are issued to Non-Resident Indians There are certain requirements for the issue of employee stock options to Non Residents outside India. Employees and directors who are outside India can receive employee stock options. The report has to be made within 30 days of the issue of the ESOP to a director or an employee. Direct Investment by Residents in Joint Venture (JV) / Wholly Owned Subsidiary (WOS) Abroad (Master Circular No. 11/2015-16) In a Master Circular issued related to Direct Investment by Residents in Joint Venture (JV) / Wholly Owned Subsidiary (WOS) Abroad (Master Circular No. 11/2015-16), there are certain compliances for employee stock options under FEMA. The rules are similar to the regulation which is brought out in 2006 related to the issue of Employee Stock Option to resident Indian from a foreign company. There are similar compliances under this. Issue of ESOPs to NRI (Employee Stock Options under FEMA) An Indian Company can issue ESOPs.ESops can be issued through the Joint Venture or the Wholly Owned Subsidiary.ESOPs which are issued must be in accordance with the guidelines which are issued by the SEBI.Reporting must be done within 30 days to the RBI for the issue of such ESOP. ESOP in an Electronic/ Cashless mode (Employee Stock Options under FEMA) Indian Employees of foreign companies can receive ESOPs in the form of cashless form. Joint Venture/ Wholly Owned Subsidiary Abroad (Employee Stock Options under FEMA) Applicable to Software Companies Employees or directors of the Indian company can purchase shares of the promoters company aboard (JV or WOS).There is a particular limit on the number of shares that are purchased. This limit is $10,000 for five calendar years.These shares are not more than 5% of the paid-up capital of the issuing company.Post allotment holding of the must not be more than the pre allotment holding. The holding by the employees and the promoter company must not be more during post allotment. ADR/ GDR (American Depository Receipts/ Global Depository Receipts) - (Employee Stock Options under FEMA) Employees and Directors who know a particular subject can purchase foreign securities under the ADR/ GDR stock option schemes.However, the maximum limit for such a form of purchase must not exceed more than $ 50000. This limit is for five years.Currently, the following sectors are considered by the government of India as knowledge-based sectors:Software;Technology;Pharmaceuticals; andBiotechnology. Conclusion for Employee Stock Options under FEMA Employee Stock Options or known as ESOPs, are issued to an employee by a company. The employee has the right to subscribe or purchase the shares of the company. While this is just considered as an employee right, it is not an obligation for an employee to purchase the shares. However, a company can buy back the ESOPs. A foreign holding company issues employee stock options under FEMA to an employee who is a resident Indian. The foreign holding company has to establish more than 51% of control over the Indian subsidiary. Compliance with other laws is mandatory for the issue of employee stock options under FEMA. The foreign company can buy back the shares from the Indian employee as long as certain conditions are followed. An Indian company can issue ESOPs to a Non-resident Indian who is working as an employee or a whole-time director of the wholly-owned Indian subsidiary. If ESOPs are issued, then certain compliances have to be followed by the Indian subsidiary. Esops are generally issued to knowledge-based work. Technology, Pharmaceutical, and Biotechnology companies would use knowledge-based work. Therefore a company that issues Esops has to be compliant with the relevant regulations. Also, Read: Procedure to Issue Shares through ESOP.