ESOP for Founders

Difference between ESOPs & Stock Appreciation Rights (SARs)

November 28, 202111002 views0

Stock Appreciation Rights or SARs are picking up momentum in India. You would have recently read about the serial entrepreneur Jiten Gupta’s startup Jupiter Money adopting Stock Appreciation Rights for their entire team (this is being managed end to end by trica equity). So, let us spend some time understanding the difference between Stock Appreciation Rights and ESOPs.

Let’s first explain to you what ESOPs are. ESOPs stands for Employee Stock Options, and under an ESOP Plan, employees are given an “option or right” to purchase the company’s shares. With ESOPs, an employee has to actually “pay” the exercise price and purchase the shares. Additionally, under Indian law, the employee is taxed on this purchase as “notional income.” The notional income is calculated as the difference between the shares’ fair market value (FMV) 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, they also have 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, they 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

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 equal to the “appreciation” or increase in the company stock price over a certain period. SARs are beneficial to the employee when the company stock price rises. In SARs programs, 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?

Instance	Tax Position
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

Note: You can give SAR/phantom stocks to consultants and part-time employees as well. Also, there is no restriction of one year cliff.

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.