Execs in a Fix Over Stock Options
To avoid high taxes, many look to get packages tweaked when they join cos, while some are giving up Esops when they exit
Sachin Dave & Sreeradha D Basu
Mumbai: As if holding on to employee stock options (Esops) worth little wasn’t bad enough, holders face a tax liability on those that have been exercised. Many did so when the options got vested in the expectation that the stock would appreciate.
Many employees of a high-profile, food-ordering startup had vested their options, which created a tax liability on the margin, the difference between purchase price and market value. In mid-2016, the startup closed, leaving several employees who had either paid tax or had a tax liability high and dry. “It is a very common occurrence where people have had to pay taxes without any payoffs. I personally know more than 30 senior executives from diverse businesses and maturity stages of their employers who had to,” said VikramBhardwaj, CEO of Redileon Partners.
In several cases, the tax liability ran into crores of rupees.
The problem is not limited to startups. At a Mumbai-based BSE-listed company that was recently referred to corporate debt restructuring, the top leadership team had to pay substantial tax while the stock languished at less than ₹ 2 per share. The employees, who were given stock options by the chairman, had decided to exercise these when the company got listed.
“Once the vesting is done, which is tax free, there would be a tax liability when an employee exercises his options but many employees time this to partial or full-exit andhence deferring their tax liability to the year in which they actually cash out,” said Amit Maheshwari, partner, Ashok Maheshwary and Associates LLP. “They take an exit when an investor picks stake in a startup or a company.”
Many senior executives are trying to work around this, especially while joining companies or startups where they are getting Esops, by getting their packages tweaked to include a higher cash component or including clauses in the employee contract safeguarding them from the tax outgo.
“Employees are all trying to avoid the uncertainty around the final tax burden on them versus the upside from selling their shares,” sa-
Experts said in many startups, expiry of the Esop is linked to the employee’s exit. When an employee leaves the organisation, he/she will have to buy the stock if it has vested, otherwise the options expire.
“Therefore, the employee incurs a tax liability on the difference bet- ween the notional value and the price at which it was issued. This is where the challenge occurs: a lot of people realise the implications of this only while going through the exit formalities,” said Anuj Roy, partner — digital practice at executive search firm Transearch. “Some at this point, are even letting go of their Esops. That is why, in actuality, real wealth creation in startups happens in very few cases. Increasingly, that is why people aren’t really buying into the Esop story anymore.”
Industry trackers said the tax liabilities are a downside of the system.
“When employees exercise their options and decide to buy shares of the company, they are accepting to take market risk at that time,” said Harshu Ghate, managing director of Esop Direct. “Most of the employees do not factor this risk when they decide to exercise and hold their shares. It is ideal for employees, especially of unlisted companies to defer their exercise closer to liquidity event.”