Restricted Stock Units: Whether ESOPs or Not?

Introduction: What are Restricted Stock Units?

Restricted Stock Units (RSUs) are a kind of performance based employee compensation granted by companies, that entitles the employee to the shares of the company (or in some cases, cash equivalent of the shares) after the vesting period is over, provided that the conditions pertaining to performance and duration of work have been fulfilled.  

The employee must only pay the par value of the share (which is only a nominal amount) and usually the only major liability of the employee is limited to paying the capital gains tax upon vesting of the shares. Some standard clauses present in most RSU plans are:

  • Vesting of shares conditional upon either company’s or employee’s performance
  • Non-transferability of the shares
  • A minimum vesting period of one year
  • No entitlement to voting unless the shares have been actually vested
  • Forfeiture in case of discontinuity of employment

The predominant purpose for issuing RSU is employee retention. Most RSU plans entitle the employee to the shares only if the employee continues to be in employment for a certain period. For example, in case vesting period is three years, with 1/3rd shares vesting each year or all shares vesting at the end of third year, then the employee is bound to stay in employment at least for three years if he/she wishes to take the shares. After the shares are vested, RSUs are treated as income and the employee is liable to pay capital gains tax on the same.

Moreover, from the point of view of employer, RSUs ensure much more predictability than Stock Options because, in case of the latter, the uncertainty of whether the employee will actually exercise his option or not is always there, but in case of RSUs, the company has much more predictability with regard to dilution of its share structure.

Regulations Governing RSUs

The term RSU has not been used either the SEBI Act, 1992, or by the SEBI Regulations pertaining to listing obligations or disclosure norms or investor protection.

The only official statement, which mentions RSUs is an informal guidance note given by SEBI on March 12, 2019, in reply to a letter filed by Infosys Limited. However, it is noteworthy that Infosys had in its letter defined Employee Stock Options specifically with reference to RSUs. Whether SEBI was mindful of this fact while giving its reply is debatable.

SEBI in its reply stated that RSUs fell within the scope of exception made for “subsisting obligations” under S. 68 of Companies Act, 2013 and therefore the company may issue equity shares as per the RSU plan after the completion of one year vesting period, even before the completion of one year period after buyback period.

Prior to 2014, there existed only the SEBI (Employee Stock Options and Employee Stock Purchase Options) Guidelines, 1999 and the question whether companies could issue stock related employee benefit schemes other than ESOPs was still a grey area. Regardless, Indian companies like Infosys (2016), MPhasis (2015), Hindalco (2013), Wipro (2012) and Tejas Networks have time and again issued RSUs and have also regularly notified the stock exchanges regarding the board meetings, for issuing RSUs along with the plan for issue of RSUs etc. The stock exchanges also did not object to the same. However, it would be wrong to say that RSUs were prohibited under the 1999 Guidelines, because SEBI vide its circular dated May 13, 2013, said that “non-ESOP based employee benefit scheme may continue as long as they are made to comply with 1999 guideline before December 31, 2013”.

The situation became much clear post the SEBI (Share Based Employee Benefits) Regulations, 2014 which permits issuance of “other general employee benefit schemes”. Therefore, for the lack of specific mention in any other regulations, it is but obvious that plans like RSUs will fall under this category.

SEBI, in its guidance note to Infosys mentioned that the same shall be without prejudice to any other existing law or regulation. Therefore, to summarize, the various regulations applicable to RSUs are as under:

  1. Companies Act, 2013
  2. SEBI (Share Based Employee Benefits) Regulations, 2014
  3. Indian Accounting Standard 102
  4. Guidance Note on Accounting for Employee share-based payments’ issued by Institute of Chartered Accountants of India
  5. Income Tax Act, 1961 & the Notification No. SO 1021(E), dated 11-10-2001 for Guidelines regarding Employees’ Stock Option Plan or Scheme.

Whether RSUs are ESOPs as per SEBI’s definition?

2 (g) of the SEBI (Share Based Employee Benefits) Regulations, 2014 (hereinafter the SBEB Regulations) defines ESOPs as “employee stock option scheme or ESOS means a scheme under which a company grants employee stock option directly or through a trust.”

2 (s) of the SBEB Regulations defines options as “option means the option given to an employee which gives him a right to purchase or subscribe at a future date, the shares offered by the company, directly or indirectly, at a pre-determined price”.

Therefore, though Restricted Stock Units may be granted either directly (Tejas Networks) or through a trust (Infosys), they are not options within the meaning of S. 2 (s) and hence not ESOS under S. 2 (g). RSUs do not give the employee the option to purchase or subscribe the share, rather they are a scheme under which the employee will be entitled to the shares at the end of vesting period so long as the restrictions relating to duration of employment and performance parameters are met. Moreover, there are a lot of conceptual differences between the two, some of which are:

  1. While the employee needs to pay the pre-determined exercise price of the share when the option is exercised, in case of ESOPS, the employee only needs to pay no or very low price for the shares, which are usually issued at par value, in case of RSUs. In the latter case, it is only after the vesting, that the employee is liable to pay tax on the acquisition of the shares
  2. In case of ESOPs, the employee may not acquire the shares if he fails to exercise the option. On the other hand, in case of RSUs, the employee is guaranteed the shares after the vesting period.
  3. ESOPs are paid with only through stocks, whereas RSUs may be paid for by stocks or cash.
  4. Under ESOPs, the employee may suffer losses if the market price at the time of vesting is less than exercise price. However, in case of RSUs, the employee remains unaffected by fluctuations in market price since exercise price for RSUs is usually the par value. Therefore, the employee is ensured a minimum return/benefit.
  5. The grants of ESOPs is not based on any conditions/restrictions. However, the employee is entitled to RSUs only on fulfillment of conditions relating to either the company’s performance or the employee’s performance.

Instead, RSUs may be more suitably placed under “General Employee Benefit Scheme” of the SBEB Regulations. S. 2(l) of the SBEB Regulations defines General Employee Benefit Scheme as “general employee benefits scheme or GEBS means any scheme of a company framed in accordance with these regulations, dealing in shares of the company or the shares of its listed holding company, for the purpose of employee welfare including healthcare benefits, hospital care … or such other benefit as specified by such company.

Whether RSUs come under Section 62 (1) (b) of Companies Act, 2013?

Though RSUs are further capital issued by the company under Section 62 of the Companies Act, 2013, the question whether they are Employee Stock Options in the strict sense under sub-section (1)(b) must probably be answered in the negative. S. 62 (1)(b) provides for issuing further shares to employees “under a scheme of employees‘ stock option, subject to special resolution passed by company and subject to such conditions as may be prescribed.” However, the pattern seen with respect to RSUs that have been issued by Indian companies is not uniform. While some authorized RSUs after a special resolution, others authorized it after an ordinary resolution coupled with a board resolution. Moreover, as mentioned before, RSUs are not options. Since, there exist significant, substantial and material differences between ESOPs and RSUs, they can’t be put in the same category.

Conclusion

Restricted Stock Units are a kind of non-ESOP based employee benefit scheme which are regulated specifically by the SEBI (Share Based Employee Benefits) Regulations, 2014 along with other applicable general laws and regulations. There currently exist no prescribed rules for issuing RSUs and therefore no uniformity can be seen in the RSUs issued in India of late. Unless the legislature or the executive takes note of the same, companies have the flexibility to model the terms and conditions of their RSUs as per their discretion.


ABOUT THE AUTHOR

Nidhisha Garg

Nidhisha Garg- Photo

Nidhisha is a final-year student at National Law Institute University, Bhopal with interest in capital markets and tax laws. She has a passion for research and writing.

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