The basics of Employee Share Option Plans (ESOPs) in Singapore

In Singapore, start-ups compete for talent with multinationals and cannot offer large paychecks compared to their large competitors. Recruiting the right talent and retaining motivated talent is vital for any company that seeks to innovate.

To this end, startups depend on alternative compensation and incentive plans to compensate their early employees. Employees who are not well compensated in cash can be compensated through an Employee Share Option Plan (ESOP).

What is an ESOP?
ESOPs give an employee the right to purchase shares in the startup at a specific pre-determined price within a certain time frame. Such plans are structured by an ESOP agreement which forms an Employee Stock Option Pool consisting of a percentage of equity shareholding. The employees are given an option to participate in the shares of the company through this pool of shares.

For example, an ESOP pool could reserve 10 percent to 20 percent of equity, of which employees could take between 0.5 percent and 3 percent. The agreement will also formulate an ESOP committee which will be responsible for managing the ESOP pool.

Advantages of ESOPs
The main advantages of ESOPs are the following:

Sense of ownership among employees
With ESOPs, employees will feel a sense of ownership of the company since they will be part owners of the company, and not just employees. The logic is that employees will give their all to create value for the company since they will benefit directly if the valuation of the company increases.

Employee retention
Employees will have to wait for a certain period of time, also called a vesting period, before they can exercise their right to purchase the shares. The vesting period is another advantage since it ensures that the employee stays with the company for a certain period of time. The employee will only be able to exercise the options after the lock-in period.

If the employee leaves before the period ends, the ESOPs are lapsed and they will not get any benefit. Three- to four-year-long vesting schedules are common, but these usually depend on the conditions of the individual start-up.

Shared entrepreneurship
In an age where innovation culture is hyped, it can be easy to forget that starting and running a business is difficult. Sharing the responsibilities of ownership among early employees can lessen the burdens of running a startup and foster a sense of shared entrepreneurship.

For instance, we all know of the PayPal Mafia, a group of PayPal founders and employees who have gone on to found additional innovative technology companies.

Taxation of ESOPs in Singapore
As talent based in start-ups in Singapore is highly mobile, taxation of any employee compensation and especially ownership plans can seem complicated. However, IRAS regulations when it comes to ESOPs are fairly simple.

Gains from ESOP plans in Singapore are taxed regardless of where the ESOP is exercised. This is relevant for expat workers in Singapore because taxation of ESOP gains will be connected to employment in Singapore and the gains will be taxable even when the ESOP is exercised after employment in Singapore has been terminated and the employee has been posted overseas.

On the other hand, if an employee is granted ESOP during overseas employment, any gains derived is not regarded as income derived in Singapore and will not be taxed in Singapore.

Deemed exercise rule
Deemed exercise rule applies when a foreigner ceases employment in Singapore or when a Singaporean Permanent Resident leaves Singapore permanently. Under the rule, the final gains from unexercised ESOPs are deemed to be income derived by the individual one month before the date of cessation of employment.

When ESOPs are taxed
Gains from ESOP plans without selling restrictions are taxable in the year when the ESOP is exercised by the employee and gains from ESOP plans with selling restrictions are taxable the restriction is lifted.