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Vikram Akula - SKS Microfinance case throws up lessons for those wanting to exercise their stock options on quitting their jobs

Vikram Akula and SKS Microfinance are making headlines again. This time because of Akula’s employee stock options (ESOPs) and the allied drama. His case is possibly far more complicated than most, given his founder status and the eventual fallout with the board. But, understanding more about it would help you know the rules related to exercising your ESOPs at the time of quitting an organisation.

The case
Before Akula resigned last November, he sent the company a letter to exercise his ESOPs at the pre-determined strike place.

What it means: By definition, a stock option is a choice to buy the company’s shares in the future at a price determined at the time of grant (strike price, mostly lower than the prevalent stock price). However, the employee can exercise this option only post the vesting period (minimum period one must stay with the employer; from one to three years).

Once this vesting period comes to an end, the employee can choose to exercise his option to buy shares anytime, even at the time of resigning from the company. According to Varda Pendse, director, Cerebrus Consultants, a human resource consultancy firm, “The agreement between the company and the employee would detail out the entire ESOP scheme and all rules pertaining to the employee exercising his options.” It would therefore, help to be clear about the fineprint of the agreement with regard to the exercise rights.

Another thing to look out for: is there an “exercise period” mentioned? At times, companies may specify the period after the vesting period over which the options may be exercised, after which period these would lapse. It could be around two to three years. Or more, like in Akula’s case, where the vesting period ended in October 2007, the exercise period ended in October 2011. However, don’t fret, as Pendse clarifies, “This is mostly for unlisted entities, not listed ones.”

The problem
SKS Microfinance claims Akula hasn’t met his tax liability with regard to the ESOPs. Hence, the allotment wasn’t made.

What it means
Esops are considered perquisites from a taxation perspective. If you are employed with the company at the time of exercising, then the perquisite amount would be added to your salary and subject to tax deducted at source as per the slab rate applicable. However, if you exercise the options after quitting the job, then the amount must be added to your overall income and taxed as per the slab rate. The onus for meeting the tax liability on this amount will be on you, just as with Akula. “The company cannot allot the shares till they know the tax due has been paid. So, typically, one can pay off the tax along with other advance taxes, if any, from his own pocket, present the challan and get the allotment,” says Sandeep Shanbhag, a chartered accountant.

The tax is levied on the difference between the amount paid by the employee to the company towards exercising the options or the strike price and the fair market value (FMV) or the stock’s closing price on the day.

The tax amount is paid on a notional perquisite here as the stocks haven’t technically been allotted. You must, therefore, either have a significant amount of cash or opt for the “flipping the option” route as suggested by Shanbhag. Here, you can sell off a part of the allotment directly to meet the tax liability, and take the remaining.

The other problem is Akula wants a refund of the Rs 4.51 crore he paid SKS Microfinance as he does not want to exercise his option anymore

Many people feel this was on the back of the company’s stock price sliding down, from Rs 218 on October 13 last year to almost Rs 102 in December, when he apparently changed his decision. The market price is higher than the strike price (Rs 49.77). But that alone cannot be a determining factor. The decision must be made after factoring in the tax liability and the subsequent gains, if any.

The decision may be especially difficult if you are resigning. Stocks are a long-term investment. “You would have to keep track of the company regularly and make decisions accordingly. For instance, say the promoters are pledging shares or cashing out, should you then stay invested in the stock?” says Tarun Gulati, founder and CEO, Just ESOPs.