Stock Appreciation Rights (SARs) are generally used in conjunction with ESOPs, as it is important to understand life cycle of SARs, taxation of SARs and difference between SARs and ESOP, before the employer rolls out incentive plans for employee. Stock Appreciation Rights is a global way of rewarding employees. SARs are increasingly seen in India as an effective way of giving stock-based compensation and, especially, as a good alternative to ESOPs. They give a lot of flexibility to companies, and with the right design, the P&L volatility can be better controlled.

Currently listed companies like L&T, JSW Steel, ITC Ltd., Marico, Diageo India and many more have given Stock Appreciation Rights to their top-level employees along with ESOP. One of the most common ways companies retain their employees is by offering ESOPs or SARs. In this blog, we look at the lesser-known incentive plan known as Stock Appreciation Rights, which has been gaining popularity recently. This could be a valuable option for startups to contemplate, offering a flexible framework that benefits both employers and employees (including contractual one) in terms of incentivization. It can assist in evaluating choices and crafting an incentive plan that aligns with your startup’s vision and goals.

Stock Appreciation Rights can be issued to payrolled employees, contractual employees as well as non-employees such as mentors, consultants, advisors, strategists etc.

What are Stock Appreciation Rights?

SARs are incentive plans that gives rights to a person to receive the appreciation in the value of a certain underlying/allocated number of shares of the company. Unlike ESOPs, there is no obligation to pay anything to receive the SARs or to exercise them.

How is Appreciation in SARs Determined?

Stock Appreciation Rights function by granting the recipient the opportunity to benefit from an increase in the estimated value of the company’s shares over a specified time frame. The appreciation is determined as the difference between the Fair Market Value (FMV) of the shares at the time of grant and FMV at the time of exercise of shares. The grant price is the price at which the SARs are issued to the employee.

Types of Stock Appreciation Rights

A SAR scheme can be either cash-settled or equity-settled.

  • Cash-settled SAR scheme: The employee receives the appreciation in cash.
  • Equity-settled SAR scheme: The employee receives the appreciation in shares
  • Combination of both cash-settled SARs and Equity settled SARs

The company may issue new shares or use existing shares from a pool to settle the SARs.

Operation of Stock Appreciation Rights

  • Stock Appreciation Rights operate in a manner largely like stock options. The SARs essentially pass through the same life cycle as ESOPs, i.e., (i) grant, (ii) vesting, and (iii) retirement of SARs and their settlement (akin to the exercise of stock options) Read more about terms of SARs which are akin to ESOP here
  • The SARs Grant (similar to ESOPs), is subject to vesting conditions determined by the issuing company, which set out the manner (including time involved and conditions for vesting) in which the SARs shall be earned by an employee/ contractual employee. However, they are not required to pay the SAR price to realise the benefit of the earned SARs.
  • Upon satisfaction of the conditions set out in the SARs Grant that entitle such employee to the benefit of SARs, the issuing company shall deliver to the employee, the value equivalent to the difference between the fair market value of the shares underlying the SARs at the time of their settlement, and the SAR price. This value can be settled either wholly in shares, i.e., equity-settled SARs, or wholly in cash, i.e., cash-settled SARs, or a combination of the two. Once the SARs are settled by the issuing company, they are considered retired.

Lifecycle of Stock Appreciation Rights

Illustrate Example on how SARs work

If a company grants 200 SARs today to an employee, having a SAR Price of INR 10 each, with an equal annual vesting schedule over a period of 4 years with a 1-year cliff (i.e., the period after which the first vesting will take place), the appreciation at the end of each year can be calculated as follows:

(Amt in Rs.)

No  Particulars  End of year 1  End of year 2 End of year 3  End of year 4 
1  Price per SARs   10  10  10  10 
2  Vested SARs (in no. of SARs) (Cumulative)  50  100  150  200 
3  % of SARs vested (progressive)  25%  50%  75%  100% 
4  Market value per SAR (in INR)  100  200  300  400 
5  Appreciation per SAR (No. 4 – No. 1) (in INR  90  190  290  390 
6  If Cash Settled SARs (No. 2 * No. 5) (in INR)  4500  19000  43500  78000 
7  If Equity Settled SARs (No. 6/ No. 4) (in no. of shares) 45  95  145  195 

The amounts and the number of shares set out against nos. 6 and 7 respectively, indicate the money or shares (as the case may be) to be received by the employee, based on the years of vesting of SARs completed, post which the SARs are being exercised/retired (i.e., at the end of Year 1/Year 2/Year 3/Year 4). As explained above, a combination of cash-settled SARs and equity-settled SARs is also possible, in which case, the relevant percentage of such combination shall be applied to nos. 6 and 7 respectively, to determine the payout and the number of shares to be issued to the employee.

How are Stock Appreciation Rights Regulated in India?

  • There are no specific regulations governing SARs under the Companies Act, 2013, for unlisted and private limited companies including start-ups. However, it is better to follow relevant regulations applicable to issuance of ESOP under the Companies Act for good governance.
  • Also, the Ministry of Corporate Affairs has recommended that SARs should be recognized and allowed under the Companies Act, 2013 through enabling provisions, subject to the approval of the shareholders in general meeting through a special resolution.
  • For listed companies, SARs are governed by the SEBI (Share Based Employee Benefits) Regulations, 2014, which prescribe the conditions and requirements for issuing and settling SARs.
  • As per the SEBI (SBEB) Regulations, 2014 allow the issuance of SARs to permanent employees and directors of the issuing company, its holding company, or its subsidiaries both in India and abroad. However, SARs cannot be granted to:
    • Independent directors
    • Directors who hold, directly or indirectly, more than 10% of the outstanding equity shares in the issuing company and
    • Promoters and individuals associated with the promoter group

Taxation of SARs in the Hands of Employee/Consultant

Stock Appreciation Rights are taxed differently based on if it is cash-settled or equity-settled, and whether the recipient is an employee or a non-employee. The below table gives a gist of taxability of SARs in the hand of employee/consultant.

Event  Cash settled SARs  Equity settled SARs 
Grant of SARs  No income-tax  No income-tax 
Vesting of SARs  No income-tax  No income-tax 
Exercise of SARs Taxed as perquisite (employee) /Income from other sources (consultant)  Taxed as perquisite (employee)/Income from other sources (consultant) 
Sale of SARs  Not applicable since they do not have any shares that are allotted.  Short term capital gain or long-term capital gain based on period of holding. (difference between sale price – FMV on date of exercise) (employee & consultant) 

 

Benefits of Stock Appreciation Rights to Recipients

  • The primary advantage of Stock Appreciation Rights for employees is that they are not required to purchase company shares. SARs do not require the employee to pay anything upfront on grant or exercise the SARs.
  • Grant of Stock Appreciation Rights for exceptional employees can be upfront in unlisted companies. Therefore, start-ups can use this avenue as strategy for retention of key person for business support and stability. Further, SAR price can vary from person to person in unlisted space.
  • When the value of the company’s stocks increases, employees will gain from the SARs in either cash or stocks (which is typically the case). In other words, using SARs, employees don’t really run any risk. However, they are vulnerable to changes in the stock market.
  • Key contractors, strategic advisors and financial consultants can negotiate SARs of the company in lieu of their legitimate payment towards various services rendered. However, the TDS and GST compliance shall be observed by the recipient of the SARs at agreed price.

Difference Between SARS and ESOPs 

SARs and ESOPs are both forms of stock-based compensation that link the employee’s remuneration to the performance of the company. However, they have some key differences in terms of their meaning, operation, ownership, dilution, taxation, and regulation. The following table summarizes the main differences between SARs and ESOPs.

Particulars  Employee Stock Option Plan (ESOP)  Stock Appreciation Right (SAR) 
Meaning  An option is granted to an employee to purchase share of the company on fulfilment of the conditions mentioned in the ESOP plan.  A right is granted to an employee to receive the appreciation in the value of a certain number of shares of the company. 
Financial Outflow  The employee has to pay the exercise price to get the shares unless they are cashless ESOPs.  The employee need not pay an exercise price to benefit from Stock Appreciation Rights. 
Ownership of Shares  The employee becomes the owner of the shares with voting benefits.  The employees do not become the actual owner of the shares. 
Dilution   The company’s ownership is diluted by the issue of new shares to the employee.  The company’s ownership is not diluted, unless the company issues new shares to settle the SARs. 
Compliance under Companies Act The listed companies are regulated by the SEBI (SBEB) Regulations, and by the Companies Act, 2013 for unlisted companies.  The listed companies are regulated by the SEBI (SBEB) Regulations for listed companies, however no specific law for unlisted companies. 
 Granted to  Employees  Employees and third-party consultant  

 

Conclusion

To sum up, the choice between ESOPs and SARs depends on the specific wants and objectives of the company and its employees. ESOPs offer a direct way to ownership, creating loyalty and wealth for the long term. On the other hand, SARs give employees the chance to profit from stock appreciation without owning shares, providing more short-term flexibility. Companies may opt for alternative forms of compensation like SARs due to less legal and compliance requirements, and a desire to retain control by avoiding the issuance of additional shares. Companies looking to align employees’ interests with long-term success may prefer ESOPs, while those seeking immediate incentives might find SARs more appropriate. In the end, both ESOPs and SARs act as powerful tools to inspire and reward employees, adding to a thriving and engaged workforce in their own different ways.

Why Choose InCorp Advisory?

Our team of professionals has expertise in managing the complexities of Indian corporates, foreign exchange, and taxation laws of different countries, including structuring of stock plans for companies ensuring optimized tax solutions for MNCs, startups, and investors. To learn more about our Taxation services, you can write to us at info@incorpadvisory.in or reach out to us at (+91) 77380 66622.

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