RSUs or ESOPs: Which Is More Rewarding?
Employee Stock Option Plans (ESOPs) and Restricted Stock Units (RSUs) are stock-based compensations awarded to employees. They offer an ownership-interest to the employees and are an excellent tool to boost their productivity, which in turn contributes to enhanced profitability.
ESOPs and RSUs are popular modes of compensation offered by companies to attract and retain talent. If you are an employee or a prospective employee looking for a job at a company offering these compensations, it is important that you understand how they work and what their potential impact on your income. This article will help you understand the features, benefits, taxability, and the differences between ESOPs and RSUs so that if confronted with a choice, you can make a more informed decision.
What Is an ESOP?
ESOPs are schemes floated by companies by virtue of which the employees of the company are given an option to purchase the company’s shares at a pre-fixed price in the near future. The pre–determined price is a price usually lower than the market value of the shares. Employees that are granted stock options can exercise their right to opt for the purchase. They are not under any obligation to purchase the shares.
Under ESOPs, employees become eligible to get stock options over a certain period of time known as the vesting period. Generally, employees can only acquire stock options if they have worked under the same employer for the entire vesting period.
For instance, if a stock option’s vesting period is 2 years, the employee will be eligible to get the stock option only at the end of the 2-year period. Once the stock options have vested, the employee can decide if they want to exercise their right to purchase the shares. The date on which the right is required to be exercised by the employee is known as the exercise date.
The price at which the shares can be purchased by the employee is usually a price lower than the Fair Market Value (FMV) of the share on the exercise date. This price is predetermined and called the ESOP’s exercise price.
Apart from the financial benefit, what makes ESOPs a popular and effective compensation tool to attract and retain talent is that it aligns employee’s interest with that of the company’s. Employees are bestowed with a sense of ownership with respect to the company and are thereby motivated to contribute to the profitability of the company.
What Are the Benefits of ESOPs?
The benefits of ESOPs for employees and employers are given below.
- Companies tend to award ESOPs to individuals reflecting exemplary performance. This has a positive externality on the productivity of the company on account of relatively more motivated individuals.
- Employers receive tax advantages with ESOPs as the ESOP expenses reduce taxable profits.If the shares are listed on a stock exchange and an employee has held them for more than 1 year before a sale, long-term capital gains (LTCG) of up to ₹ 1,00,000 can be subjected to Tax Exemption. Any LTCG above ₹ 1,00,000 is taxed at a 10% rate.
- This type of compensation acts as an incentive for employees to keep up their good work, as the company’s improvement directly benefits them.
- For start-ups that are looking forward to expanding their business, ESOP is a much more feasible option than cash rewards.
- ESOPs also offer an easy transfer of stock options, making it a great option to save for retirement. Employees can own a part of the company’s ownership for as long as they want or sell them when its value rises.
- ESOPs make a company package look much more attractive, they serve as an added benefit with salary. Thus, attracting talented minds to the company.
- Employees cannot enjoy these vested shares if they leave their company before the vesting period ends. Thus, ESOPs allow companies to reduce their attrition rate.
What is a Restricted stock unit (RSU)?
RSUs are a type of employee compensation. As the name suggests, there are certain restrictions attached to RSUs.
Similar to ESOPs, RSUs are subject to a vesting period. Post a predefined vesting period, the employee is granted shares by the employer when they fulfil certain conditions. In contrast to ESOPs, RSUs are a simpler form of employee compensation as there is no exercise price required to be paid by the employee.
Typically, employees get RSUs when they fulfil certain parameters like surpassing a performance metric or staying employed for a specific period of time.
RSUs do not have any tangible value until the end of their vesting period. At the end of the vesting period, they can be held or sold just like any other share of the company.
What Are the Benefits of RSUs?
The benefits of RSUs for employees and employers are given below.
- As they do not have a tangible value till the end of the vesting period, they are not an immediate cost to the employer.
- Like ESOPs, RSUs act as an incentive to boost employee morale and make the employees stay longer.
- Inspires employees to perform their best and meet all conditions relating to the grant of RSUs.
- For employees, these provide immediate monetary value after the vesting period.
- RSUs are generally granted over a clear and simple vesting schedule.
How Are ESOPs and RSUs Taxed in India?
Tax implications for ESOPs and RSUs, according to the Income-tax Act, 1961, are provided below.
Tax Implications for ESOPs & RSUs
ESOPs and RSUs are taxed at two stages:
- At the time of exercise
When an employee exercises an ESOP, the difference between its FMV and exercise price is called its perquisite value. The perquisite value is taxable for the employee under the head ‘Salaries’. The rate of tax will apply based on the income tax slab of the employee.
Since RSUs do not have an exercise price, their FMV on the date of exercise is taxable as a perquisite in the hands of an employee.
- At the time of sale
When an employee sells shares acquired through ESOPS or RSUs, the difference between its selling price and FMV at time of exercise is considered capital gains. Any other expenses incurred by the employee in acquiring these shares can be reduced from the capital gains.
To determine the applicable rate of tax on capital gains arising from sale of shares, the gains have to be categorised as long-term or short-term on the basis of the period for which the shares were held. The period of holding differs for shares that are listed on stock exchanges and unlisted shares. The rate of tax that should apply is tabulated below:
Type of share
Period of holding for long-term capital gains
Period of holding for
short-term capital gains
Rate of tax
More than 12 months
Less than or equal to 12 months
Long-term capital gains: Exempt up to ₹ 1,00,000 and 10% above ₹ 1,00,000.
Short-term capital gains: 15%
More than 24 months
Less than or equal to 24 months
Long-term capital gains: 20%
Short-term capital gains: As per income tax slab rate
Differences Between ESOPs and RSUs
Although RSUs are a type of ESOPs, there are some differences between the two. So first, let’s look into the differences between RSUs and ESOPs.
|Employee Stock Options Plan (ESOPs)||Restricted Stock Units (RSUs)|
|ESOP cost can be calculated using this formula:Exercise price x Number of exercised shares||Employees do not bear the cost of RSU|
|They are riskier than RSUs as there is a possibility that the value of the shares may fall below their exercise price||They are less riskier than ESOPs as the employees do not incur any exercise price|
|These are options which grant rights to purchase stocks||RSUs once vested lead to direct acquisition of stocks|
|Employees should take action to exercise stock options in ESOPs||Employees do not have to carry out any action to benefit from RSUs|
|Popular among start-ups at their initial stage||Mature and later-stage companies mostly offer RSUs|
Which Is More Rewarding – ESOPs or RSUs?
As we know the points of differences between ESOPs and RSUs, it is quite clear both come with their pros and cons.
One must be able to gauge the company’s performance in the future to know which is better between ESOPs and RSUs. For example, stock options are good when their FMV is higher than their exercise price during vesting. On the other hand, RSUs are incentives for which an employee does not have to pay.
Keeping these points in mind, the choice of the better option has a subjective answer. Many employers prefer ESOPs, while many employees feel RSUs are better. One can read the above sections to make a well-informed decision on the right employment benefit.
Frequently Asked Questions
How many types of ESOPs are there?
There are mainly five types of ESOPs. These are Employee Stock Purchase Plan, Phantom Equity Plan, Employee Stock Option Scheme, Restricted Stock Awards, and Restricted Stock Units.
What are NSOs and ISOs?
Non-qualified Stock Options (NSOs) and Incentive Stock Options (ISOs) are two types of stock option plans. ISOs allow an employee to purchase shares of a company at a discounted price with a few tax benefits. NSO is a stock option wherein an employee must pay the difference between the grant price and the exercise price of the stock.
What can I do with RSUs after vesting?
An employee can earn hefty profits on selling RSUs after the vesting period. Moreover, they can grab the opportunity to sell their stocks when the market is rising.