Stock Appreciation Rights or SARs are picking up momentum in India and you would have recently read about serial entrepreneur, Jiten Gupta’s startup Jupiter.money adopting Stock Appreciation Rights for their entire team (this is being managed end to end by MyStartupEquity). So, let us spend some time to understand the difference between Stock Appreciation Rights and ESOPs.
Let’s first explain to you what ESOPs are. ESOPs stand for Employee Stock Options and under an ESOP Plan employees are given an “option or right” to purchase the shares of the company. With ESOPs an employee has to actually “pay” the exercise price and purchase the shares. Additionally, under Indian law, the employee is also taxed on this purchase which is seen as “notional income”. The notional income is calculated as the difference between the fair market value (FMV) of the shares and the exercise price. The employee needs to pay income tax on this notional income based on his tax bracket.
So, not only did the employee have to shell out a certain amount (can be substantial if the exercise price is high) to buy the shares, he or she also has to immediately have enough financial resources to pay the tax on it. Furthermore, with ESOPs when the employee actually “sells” the shares during a liquidity event, he or she will again be taxed – this time it will be capital gains tax depending on the period for which the “shares” were held. This is the dreaded “double taxation” that everyone talks about. (You can read more about taxation on ESOPs here.)
Stock Appreciation Rights
Now, with Stock Appreciation Rights (SARs) an employee does not have to “purchase” the shares or “pay” the exercise price. You can think of SARs as a form of bonus compensation given to employees that is equal to the “appreciation” or increase in price of the company stock over a certain time period. SARs are beneficial to the employee when the company stock price rises. In Stock Appreciation Rights programmes, employees do not have to pay the exercise price but receive the sum of the increase in the stock price as either stock or cash or a combination of both. This sum is treated as a “perquisite” received and taxed as salary income based on the employee’s tax slab.
How will Stock Appreciation Rights (SARs) be taxed?
|Grant||No income tax in the hands of the employee|
|Vesting||No income tax in the hands of the employee|
|Exercise||This sum will be treated as a “perquisite” received & taxed as salary income based on the tax slab|
Here’s a small table encapsulating the main differences between SARs and ESOPs
|Stock Appreciation Rights||Employee Stock Option Plan|
|No obligation of an upfront payment by the employee||Employees are usually required to pay the exercise price before they can get the shares|
|No taxation in the hands of the participants on granting or vesting||Employees are taxed on exercise price without any cash receipt|
|May receive stock or cash or a combination of both||Actual shares to be issued and shareholders protection rights need to be built in|
|Taxed as Perquisites||Taxed as part Perquisites & part Capital Gains|
To understand more about Stock Appreciation Rights you can watch this video where Siddarth Pai of 3one4 Capital talks about the advantages of using SARs.
You can join our webinar with Jiten Gupta on July 9. Register here.
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