ESOP Vs ESPP in India

When Indian companies talk about employee ownership, two terms come up often, ESOP and ESPP. Both sound similar, but they work very differently.

ESOP (Employee Stock Option Plan) gives employees the right to receive or buy company shares in the future, usually at a fixed (strike) price, as part of their compensation.

ESPP (Employee Stock Purchase Plan) allows employees to buy company shares at a discounted price, using a portion of their salary.

What is an ESOP in India?

An Employee Stock Option Plan (ESOP) is a structured way for Indian companies, especially early-stage and unlisted entities, to offer employees an ownership stake in the business.

Instead of giving shares immediately, the company grants options, which give employees the right (but not the obligation) to purchase shares at a predetermined price after completing a specific vesting period.

This mechanism aligns employee interests with the company’s growth. If the company’s valuation rises, employees benefit from the upside when they exercise their options.

Why companies use ESOPs

Nearly 62% of companies in India have implemented ESOPs.

• 87% say ESOPs help with retaining existing talent
• 92% believe they build culture and creates a sense of ownership
• 83% feel they help in attracting new top talent
• 25% see them as a way to reduce costs and improve liquidity

Employee interest in equity awards is on the rise, since it provides an opportunity for wealth creation. As many as 23 startups undertook buyback schemes, which helped 3K+ employees generate wealth worth more than INR 1,448 Cr. in 2024.

ESOP vesting, exercise, and buyback rules in India

In India, all vesting, exercise, and repurchase terms for ESOPs are defined in the ESOP scheme document and the individual grant letter, but they must comply with the Companies Act, 2013 and related rules.

Vesting

ESOPs vest over time or based on performance milestones. The minimum vesting period under Indian law is one year from the grant date. Most startups use a three to four-year vesting schedule with a one-year cliff to encourage retention.

Exercise on exit or retirement

a. Voluntary resignation: Employees typically have 30–90 days after their last working day to exercise vested options. Some progressive companies extend this exercise window to as long as 10 years from the last working day. All unvested options lapse automatically.

b. Retirement, death, or permanent disability: Most ESOP plans provide for accelerated vesting or an extended exercise period (often up to the plan’s expiry).

c. Termination for cause: All unexercised options, vested or unvested, generally lapse immediately.

Buyback or liquidity

For private companies, liquidity is usually provided through an ESOP buyback window or a secondary sale during a funding round. Shares are repurchased at the latest Fair Market Value (FMV) certified by a SEBI-registered merchant banker.

For listed companies, employees can sell their shares directly on the stock exchange once the shares are allotted and any holding period has passed.

What is an ESPP in India?

An Employee Stock Purchase Plan (ESPP) gives employees the opportunity to purchase company shares, usually at a discount of 5% to 15%, through regular payroll deductions. 

It’s designed to encourage employee ownership and align individual interests with the company’s long-term growth.

While ESPPs are well established in listed Multinational Companies (MNCs), a growing number of Indian subsidiaries of global firms now offer them to their local employees as part of broader global equity programs. 

For Indian listed companies, ESPPs must comply with SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021.

How does an ESPP work?

a. Enrollment‍

Employees choose to participate and decide what percentage of their monthly salary (for example, 5–10%) they want to contribute toward purchasing company shares.

‍b. Payroll deduction‍

The selected amount is automatically deducted from each salary cycle and set aside in a designated account during the plan’s offering period.

c. Purchase date‍

At the end of the offering period, usually 6 to 12 months, the accumulated contributions are used to buy company shares. Most plans apply either a discount (say 15%) or a look-back feature, which allows employees to buy at the lower of the share price at the start or end of the period.

‍d. Allotment‍

Once shares are purchased, they are credited to the employee’s demat account or a brokerage account.

For example, an employee earning ₹1,00,000 per month contributes 10% of salary for six months.

Total contribution: ₹60,000
Stock price: ₹100 at the start of the offering period, ₹120 at the purchase date
ESPP discount: 15% on the lower price (₹100) → purchase price = ₹85 per share
Shares allotted: ₹60,000 ÷ ₹85 = 705 shares
Unrealised gain at purchase: (₹120 – ₹85) × 705 = ₹24,675

The gain remains “unrealised” until the employee sells the shares, but it demonstrates how ESPPs can offer immediate value and long-term upside if the company’s stock performs well.

ESOP vs ESPP 

How ESOPs are taxed in India

Taxation happens at two stages: on exercise and on sale.

a. At exercise

The difference between the FMV on the exercise date and the exercise price is taxed as a perquisite under “salary income”.

The employer deducts TDS on this perquisite value.

b. At sale

The difference between sale price and FMV at exercise is taxed as capital gains.

If the shares belong to an unlisted company:

Held for more than 24 months → Long-term capital gains (LTCG) taxed at 12.5% without indexation.

Sold within 24 months → Short-term capital gains (STCG) taxed at the employee’s income tax slab rate.

If the shares belong to a listed company:

Held for more than 12 months → LTCG taxed at 12.5% (without indexation) on gains exceeding ₹1.5 lakh in a financial year.

Sold within 12 months → STCG taxed at 20%.

Note: The holding period for ESOP shares is counted from the date of exercise, not from the date of grant.

💡 Special case for DPIIT-registered startups: Employees can defer perquisite tax payment for up to 5 years (or until they sell shares, or leave the company, whichever is earlier) under Section 156(2) of the Finance Act, 2020.

How ESPPs are taxed in India

Like ESOPs, ESPPs are also taxed in two stages: at the time of purchase and at the time of sale.

a. At purchase: The discount (difference between the FMV on the purchase date and the actual purchase price) is taxed as a perquisite under “salary income.”

b. At sale: The difference between the sale price and the FMV on the purchase date is taxed as a capital gain.

How ESOPs are funded and structured

Indian companies can design and fund ESOPs in a few different ways, depending on their size, stage, and ownership structure. 

The framework must comply with Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014 and, for listed companies, SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021.

1. Trust-based vs. direct route

Direct issue: The company grants options and, when employees exercise them, issues fresh shares directly to the employee.

Trust route: A separate ESOP trust (an employee welfare trust) is created to hold shares on behalf of employees. The trust may:

• Subscribe to new shares issued by the company, or
• Purchase existing shares from promoters or the market, financed through loans from the company. The trust later transfers shares to employees when they exercise their vested options.
  

2. Funding methods

• Company contribution or loan: The company can lend funds to the ESOP trust to buy shares at the outset. Repayments are usually made from the exercise price paid by employees or from dividends received on shares held by the trust.
  
• Fresh share issuance: Instead of funding a trust, the company can simply issue new shares at the time of exercise. .
  
• Secondary purchase: In mature or well-funded startups, the ESOP pool may be replenished through buybacks or secondary sales from existing shareholders to the trust or employees.
  

3. Repurchase obligations‍

In private companies where shares are not freely tradable, employees often need a way to realise value. To address this, companies may:

• Organise periodic ESOP buybacks at the latest FMV, or
• Facilitate secondary sales to incoming investors during funding rounds.

These mechanisms ensure liquidity and maintain employee confidence in the ESOP program.

4. Governance and accounting

• The company or the ESOP trust must maintain clear records of grants, vesting, exercises, and share transfers.
• Any shares held by the trust that have not been allocated to employees are excluded from voting and dividend rights.
• The cost of ESOPs (based on fair value at the grant date) is recognized as an employee compensation expense under Ind AS 102 in the company’s financial statements, spread over the vesting period.

FAQs on ESOP vs ESPP in India

1. What is the difference between ESOP and ESPP in India?

ESOPs give employees an ownership stake through company-granted options, while ESPPs allow employees to buy stock at a discount using payroll deductions. ESOPs are employer-funded; ESPPs are employee-funded.

2. How are ESOPs taxed in India?

ESOPs usually trigger two taxable events: first, a perquisite tax at the time of exercise, and later, a capital gains tax at the time of sale. Employees of DPIIT-registered startups can defer the perquisite tax payment for up to five years, or until they sell the shares or leave the company, whichever comes first.

3. How are ESPPs taxed in India?

ESPPs also trigger two taxable events. The discount received on purchase is taxed as a perquisite, and profit on sale is taxed as capital gains depending on holding period.

4. Is ESOP part of CTC?

Yes, some companies include ESOPs in the CTC as part of long-term or deferred compensation. However, this value is only indicative, since it depends on future company valuation, vesting, and liquidity events. ESOPs represent potential future wealth, not guaranteed cash income.

5. Is ESOP better than salary?

They serve different purposes. Salary is fixed, predictable, and immediately available, while ESOPs are variable and depend on the company’s growth and eventual liquidity event. ESOPs can create significant long-term wealth if the company performs well, but they carry higher risk and no immediate payout. For most employees, the ideal compensation mix includes a stable salary for short-term needs and ESOPs for long-term upside.

6. Is it good to buy ESPP?

If the plan offers a meaningful discount and the company has strong fundamentals, participating in an ESPP can be a smart, relatively low-risk way to build wealth. The built-in discount (often 10–15%) provides an immediate gain, and features like a look-back provision can further boost returns if the stock price rises. However, remember that ESPPs still carry market risk, and gains are subject to tax. It’s wise to participate at a level you’re comfortable with, review the plan’s holding period, and avoid over-concentrating your portfolio.

7. Which is better, ESOP or RSU?

In India, ESOPs are more common in early-stage companies, while Restricted Stock Units (RSUs) are typically offered by listed companies or global subsidiaries. RSUs are simpler to understand and usually more liquid, since shares are granted outright once they vest. ESOPs, on the other hand, require employees to exercise and pay an exercise price but can offer higher upside if the company’s valuation grows significantly before exit. The better option depends on your priorities.