The Legal Framework of Employee Stock Option Plan (ESOP) in Nepal

Introduction

ESOP, in broad sense, is an equity compensation plan that is provided by the employer of a company to its employee at a present date with a right but not obligation to purchase a certain number of shares in the future at a predetermined rate. Such options are generally provided by start up companies. Many shareholders of prominent and successful companies such as Microsoft, NVIDIA have become millionaires by obtaining and holding onto such options.

How an ESOP Operates

Under an ESOP, the company first makes a grant, which is the formal offer of options to an employee. The price at which the employee may later buy each share is fixed at this initial stage and is called the exercise price (or strike price), so the purchase price stays the same for the employee even if the company’s value rises. The employee cannot buy right away and must first complete the vesting period, which is the waiting time of continued service (and sometimes performance targets) after which the options become theirs. Once vested, the employee may exercise the options, meaning actually buying the shares at the exercise price, within a set exercise period. If the employee does not exercise within that window, the options generally lapse. If the shares are worth less than the exercise price, the employee can simply choose not to buy.

Why Companies Offer ESOP?

It rewards employees that are valuable to the company and have been working loyally for a considerable amount of time. Likewise, it helps to retain existing employees and works as a key recruiting tool to attract new employees too. It allows companies to provide alternatives to compensation(salary) and helps to better manage liquidity. It incentivizes the employees to help the company grow and succeed as they share ownership as well contributing directly to job satisfaction of employees as well.

ESOP Agreements

ESOP agreement refers to the agreement made between grantor(employer) and grantee(employee) that defines the terms and conditions of the offered ESOP. Such agreement may include vesting schedule, number of shares, exercise price during the offer, exercise period, employment termination consequences,etc. It may also include that such shares may vest only in chunks i.e. a certain percentage of the total number of offered shares are vested at different intervals of time. For example; a total number of 100 shares are offered at year one, then the agreement may state that in every 2 years, 25 shares can only be vested.

Types of ESOPs

In many countries including USA, ESOPs are generally categorised into two types which are as follows:

1. Incentive Stock Option.

It is also known as statutory or qualified options. Such types of options are generally offered to key employees or top management of the company. The major distinguishing factor is that the Internal Revenue Service(IRS)(in context of the US) recognizes this as a long term capital gain and hence it receives preferential tax treatment.

2. Non qualified stock options

These options are generally offered to all members of the company. It is considered as ordinary income by the IRS and does not receive preferential tax treatment like Incentive stock options.

ESOPs under Company Act, 2006 (Nepal)

ESOP in Nepal, is a new and growing concept. The Company Act,2063, specifically the section 66A reflects provisions relating to ESOP. It provides rules and regulations relating to how companies may establish and conduct ESOP plans to their employees and directors. It specifies such plan as a right rather than an obligation on part of employees. It requires special resolution in the general meeting for providing such plans to its members. It also mandates details to be included in such plans including but not limited to number of shares, number of years, exercise price, vesting period, etc.

Likewise, there have been other provisions included in the Company Act, 2063 even before the new amendment. It includes Section 9(3); which does not count shareholders under Section 66A as regular shareholders, Section 62(proviso) and 64(2c) which provides provisions for giving loan and discount on purchase of such shares, Section 61(4c) which provides rules on how company can buy back such shares.

ESOPs in Publicly Listed Companies

ESOPs in context of Publicly traded Companies are more tightly controlled than in private companies. Besides the Company Act, 2063, they are also governed by the Securities Issuance and Allotment Guidelines, 2074. Under Section 5 of the Guidelines; listed companies may allotupto 5% of their total capital to its employees. However, such securities may not be allocated to project-based or part-time employees.

Likewise, the maximum threshold of distributing 5% of the capital is also not a flat figure as the share a company may actually distribute varies with the number of employees it has. The table below sets out the permitted percentage for each employee range.

Number of employees	Share percentage
1-50 employees	2 %
51-100 employees	3 %
101-200 employees	4 %
Above 200 employees	5 %

Once an employee has exercised their options, the securities acquired become ordinary shares of the company (subject to restrictions on voting rights). In a publicly traded company, the employee can then sell them on the secondary market at the prevailing market price, subject to any lock-in period set by the plan or by law. Any profit on that sale is generally treated as a capital gain, separate from the benefit taxed at the time of exercise

Taxation of ESOPs

During vesting period, ESOP is usually vested at market price of the shares and this typically leads to a discount and capital gain during disposal; triggering tax implications. In most jurisdictions, employee stocks are taxed at two instances.

1. During the purchase of shares (i.e. exercise of option), because the purchased shares are usually bought at a discounted price or a price below market value, and hence it is considered as a gain for the purpose of tax by the law. In Nepal, employment income includes any benefit received from employment. It is important to note that Nepal does not have a dedicated ESOP tax framework, and the following analysis is based on general principles under the Income Tax Act, 2058. Since remuneration from employment includes salary, commission, bonus, gifts, facilities and other payments made in respect of employment, any benefit received by an employee through the acquisition of shares at a discounted price under an ESOP may be treated as employment income. Further, where property is transferred or a benefit is provided, the value of such benefit is generally determined based on its market value. Therefore, where the market value of a share exceeds the price paid by the employee under an ESOP, the difference may potentially be treated as a taxable employment benefit.

2. After such purchase (exercise), if the shares are sold in the market at a profit, then it is considered as a capital gain and is taxed accordingly as well. However, where an employee purchases company shares at the same price available to the general public without receiving any employment-related discount or benefit, such acquisition would generally be treated as an investment rather than employment income, and any gain arising on the subsequent sale of such shares would be governed by the capital gain provisions.

Furthermore, Short-term capital gains are considered as a part of employment compensation and are taxed at ordinary income rates. While long-term capital gains are considered as capital gain and lower tax rates are applied to it, in comparison to short-term capital gains in most jurisdictions.

Challenges and Complexities of ESOPs

1. ESOPs are difficult to trade/sell, especially in the context of unlisted public and private companies. Such stocks lack a specific market price and are based on assumptions regarding price, interest, potential, etc. and hence it is difficult to determine the price of such stocks.

2. ESOPs require a certain level of seniority or performance target before it is actually vested. So, if the provisions of the agreement are vague and unclear on such an instance, it may give rise to legal situations. Some provisions prevent the sale or disposal of such stocks up to certain years, this may incite conflict between the employee and employer, as the employee is unable to sell the stocks even after paying tax at purchase(prerequisite stage).

3. ESOPs generally return profit at the end of the maturity period. But there is no guarantee that the company will succeed, so there always remains a risk of failure or bankruptcy of the company.

Conclusion

ESOPs have emerged as an important tool for aligning the interests of employees and companies by providing employees with an opportunity to participate in the future growth and success of the business. While they offer significant benefits in terms of employee retention, motivation, and wealth creation, they also involve legal, tax, and valuation complexities that must be carefully considered. With the recent introduction of specific ESOP provisions under the Companies Act, 2063, Nepal has taken a positive step towards encouraging employee ownership and modern compensation practices. As startups and growing businesses continue to expand in Nepal, ESOPs are likely to become an increasingly important component of corporate and employment structures.

(Written by: Aman Karmacharya, Junior Associate, Vidhi Legal Concern: Dated: 3rd Nov,2026)

Disclaimer: This note is not a legal opinion but for general understanding. It is advised to consult a lawyer for legal advice before initiating ESOP related documentation . Please note that the copyright for this note vests on Vidhi Legal Concern.