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Employee Stock Option Plan (ESOP) in Singapore – Essentials That You Need to Know

Human resource is one of the important assets for a company. Many times, companies will try to outdo their competitors in a war of talents by giving more employee benefits or compensations. Employee Stock Option Plan (“ESOP”) is one of the additional incentives that a company can offer, which is also a popular type of employee compensation that could win the race.

Employee Stock Option Plan (ESOP) in SingaporeWhat is an Employee Stock Option Plan (ESOP)?

An ESOP, as the name suggests, grants employees the company share’s purchase right at a pre-determined price for a finite period, with the terms of employee stock options fully stipulated in an employee stock options agreement. The company’s board of management will administer the ESOPs and set the rules of the scheme. The company’s board of management will also set the exercise price of the ESOP, where the price set is as close to the share’s market value as possible.

Why Use ESOPs?

Setting up ESOP implies that a company is offering its employees a slice of the pie. With the ESOP, the employees are standing chances to benefit directly from an increase in the value of the company that, in turn, will motivate employees to work harder, cultivate employment loyalty, and promote long-term commitment. ESOP creates a sense of ownership the company confers on employees, and it further incentivises employees to commit long-term. It is because the designated time (before employees are eligible for ESOPs) will encourage employees to commit long-term to take advantage of their share options. On top of the boosted staff morale and employee loyalty, ESOPs are seen as other means of compensation for smaller companies. It is particularly advantageous if these smaller companies are having troubles paying salaries to their staff in cash – the company share (that equals to their employees’ salary) could be utilised to compensate the staff.

Among many others, the advantages of having ESOPs are concluded as below:

  1. It could be part of staff remuneration package
    As mentioned above, the ESOP is especially powerful when used to remunerate staff. A remuneration package could be supplemented with share options to close the gap between what a company can pay their employee and what the market salary is. Furthermore, ESOP boosts job satisfaction among employees and improves employees’ financial wellbeing with lucrative incentives. Ultimately, a share option will help the company to stand out from the crowd and attract talents easily.
  2. It builds value for the company
    As mentioned above, an ESOP creates a sense of belonging and ownership among employees. When the staff feel like they own a stake of their company, this sense of ownership will inspire them to work diligently, and incentivizes employees to help the company to grow and succeed.
  3. It retains talents
    An ESOP may have vesting periods. Under such circumstances, most employees (under the ESOP) are willing to stay and commit until they are eligible to exercise their options.


What to Be Considered When Implementing ESOPs?

The implementation of ESOPs is not always a bed of roses. You will need to factor in several issues in the consideration:

  1. Acknowledge the complexity of setting up the ESOP
    Though setting up an ESOP is flexible, there are complex procedures, rules, and regulations to be followed in each aspect. Furthermore, the initial cost of setting up an ESOP is will cost you an arm and a leg and it always involves a lawyer.
  2. Decide the percentage of the equity to set aside for your ESOP
    While there is no real hard rule about how big a company’s ESOP should be, it is advisable that the company should set a threshold on the amount of equity that is to be shared with the employees.
  3. ESOP might lead to share dilution
    Share dilution is one of the possible issues that might arise with the implementation of ESOP. ESOP leads to ownership distribution among many individuals and it decreases the existing shareholders’ ownership of the company when the company issues new equity. While the new equity increases the total shares outstanding, it has a dilutive effect on the ownership percentage of existing shareholders. As such, to mitigate the risk where option holders are unable to block the company’s sale or merger, the board of management of the company always include a clause for drag-along rights. The specific clause for drag-along rights spells out the rights of a specified majority of shareholders that they could force minority shareholders to sell their shares on receipt of a third party offer.
  4. Scenarios when an employee resigns after shares have been vested
    The ESOP agreement must include a clause that stipulates what happens when an employee who holds an ESOP resigns. In general, an employee will forfeit all his unvested options but retains the vested options until a specified short period when he or she leaves the company.


What Are the Important Terms in an Employee Stock Option Plan (ESOP)?

Every company can have its own ESOP. Though ESOPs vary between individual companies, a good ESOP should have the following:

  • Eligibility criteria: this spells out who is eligible for the ESOP and who is not. A company intends to offer ESOP must have a set of eligibility criteria in place to qualify or disqualify certain employees from participating in the ESOP.
  • A designated period of time and/or a set of conditions stipulating when the employees could purchase the company’s shares.
  • A well-defined presence or absence of a vesting period.
  • The ESOP committee’s members, as well as the functions of the ESOP committee.
  • Number of ESOP shares issued.


Employee Share Ownership Plans (“ESOW”) vs ESOP

An Employee Share Ownership Plan (“ESOW”) is any plan that allows an employee of a company to either own or purchase company shares (or in its parent company). Generally, ESOWs exclude phantom shares and share appreciation rights. Phantom share is a form of compensation that promises cash bonus payout, either in cash or in a form of equity, that is equivalent to the value of company shares, or the increase in that value, over a designated time. Meanwhile, share appreciation rights works similarly as the phantom shares, but it grants employees the right to a cash equivalent of the increase in the value of a pre-fixed number of shares, over a pre-determined period of time.

An ESOP is a specific type of ESOW where employees have the rights to purchase company’s shares at a pre-determined price within a specific period of time.

How to Structure an Employee Stock Option Plan (ESOP)?

You may structure your company’s ESOP based on your company’s financial health, needs, and objectives. You can factor in questions like how should you remunerate your employees according to market standards, how much should you value your stock options at, as well as how many stock options should you grant, if you are weighing the decision of setting up an ESOP.

Essentially, an ESOP has the following criteria:

  1. The ESOP Agreement and ESOP committee
    A well-drafted ESOP Agreement will structure the ESOP by creating an Employee Stock Option Pool (ESOP Pool) that puts aside a percentage of equity shareholding for employees. Therefore, employees can take part in the company shares through this pool of shares. Furthermore, an ESOP Agreement will spell out the details of members of an ESOP committee. The ESOP committee, as the name implies, is a committee consists of the company’s directors and other officers. The ESOP committee has the responsibility to manage the ESOP Pool and recommend suitable actions to the Board of Directors of the company.
  2. The Cliff and Vest period
    A Cliff and/or Vest period could be part of the ESOP. A Vesting schedule implies that employee will get his or her shares over time and not all at once. Meanwhile, a vesting “cliff” essentially means that there is a period of time of no vesting, but the benefit will become fully vested when the specified time (the “cliff”) is hit.
    Most of the time, if an employee who holds ESOP resigns during the Cliff period, he/she will not receive any stock options. The Vest period, on the other hand, means the period of time before shares in an ESOP are unconditionally owned by the employee. If an employee resigns during the Vest period (which usually succeeds the Cliff period), he or she will be given pro-rated stock options based on the length of his or her employment.
  3. Selling Restriction
    A company may include a selling restriction in its ESOP, or a period within which an employee is not allowed to sell his or her shares.


Tax Implications


A company with ESOP is eligible for tax deductions on costs incurred to acquire its own shares (i.e. treasury shares) applied for the benefit of employees. The timing for the company to be allowed tax deduction is when the shares vest to the employees. For ESOP, this typically occurs when employees exercise their stock options.


An employee who is granted share options by the employer will be taxed on any gains or profits arising from the exercise of the share option. The timing of taxation is based on when the share option is exercised or when the selling restriction has been lifted. The amount of taxable gain is the difference between the open market price of the shares at the time of exercise/selling restriction has been lifted and the amount paid by the individual for such shares.

For gains arising from an ESOP with no selling restriction, it is taxable in the year when the share options are exercised. For ESOP with selling restriction, gains generated from the ESOP will be taxed only in the year when the selling restriction is lifted.

There is a “deemed exercise” rule for foreign employees when they cease Singapore employment. Under “deemed exercise” rule, the foreign employee is deemed to have derived a final gain when he ceases employment in Singapore on unexercised ESOPs or ESOPs where the selling restriction has not been lifted. Final gains are deemed to be income derived by the individual one month before the date of cessation of employment or the date the right is granted, whichever is the later.

Tax deferment option

Subject to qualifying conditions, employees can choose to defer the payment of tax (subject to an interest charge) on the gains from ESOP for any period of time (e.g. 2 or 3 years) up to a maximum of 5 years. The tax-deferred and interest charged will become due on the expiry of the deferral period.

For an ESOP to be eligible for tax deferment, the ESOP must meet the following conditions:

  • The ESOP cannot be exercisable within a year from the grant of the option if the exercise price of the option equals to or is more than the open market price at the time of being offered. For the case of the exercise price being less than the open market price, the vesting period requirement will go up to 2 years. For a company that is not a listed company, the company’s net asset value will be used in place of the open market price.
  • For ESOP with a staggered vesting period, only the proportion of shares that have not vested may be qualified for tax deferment.
  • At the time the ESOP is granted, the employee must still be working in Singapore.
  • The employee (who receives the share option) must be someone who
    • is not an undischarged bankrupt,
    • does not have a poor tax-paying record,
    • possesses tax on stock options gains more than $200,
    • has not been granted area representative status, and
    • is eligible to settle tax by instalments under current tax rules.

To conclude, ESOPs are powerful incentives as part of the staff remuneration package to retain talents, boost staff morale, and create a sense of belonging among employees. Every company, no matter of its size or industry, can consider setting up ESOPs.
Employee Stock Option Plan (ESOP) in Singapore