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Employee Stock Option Plan (ESOP) and its taxability

Affluence Advisory , Last updated: 23 May 2023  
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What is ESOP?

ESOP are employee benefit plans that offer employees ownership interest in the organization they work. In other words, ESOP are the right / option given to eligible employees by the employers to buy equity shares of the company at a predetermined rate within a stipulated time.

Some key terms used in ESOP are as follows

  • Grant date is the date of the agreement between the employer and employee to give an option to the employees to own shares (at a later date).
  • Vesting date refers to the date the employee is entitled to buy shares after conditions agreed upon earlier are fulfilled.
  • Vesting period is the time period between the grant date and vesting date
  • The Exercise date is when the employee exercises the option of buying shares.
  • Exercise period is a period once stocks have 'vested', the employee now has a right to buy (but not an obligation) the shares of the company for a period of time.
  • Exercise price is a price at which employee exercises the option. This price is usually lower than the Fair Market Value of the shares.
Employee Stock Option Plan (ESOP) and its taxability

Taxation of ESOP's

Tax is levied at two points in ESOP.

  • First Trigger of ESOP taxation will be at the event of exercising ESOP
  • Second trigger will be at the time of sale of shares

First Tax Trigger - When ESOP's are Exercised - It will be taxable as part of Salary (Perquisite)

When the employee has exercised the option, basically agreed to buy the shares under ESOP, the difference between the FMV (fair market value) on exercise date and exercise price is taxed as perquisite.

The employer deducts TDS on this perquisite. This amount is shown in the employee's Form 16 and included as part of the total income from salary in the tax return.

Important Note for Eligible Startup

The Budget 2020 amendment, however, said that from FY 2020-21, an employee receiving ESOP from an eligible startup need not pay tax in the year of exercising the option. The TDS (tax deducted at source) on the 'perquisite' stands deferred to the earlier of the following events :-

  1. Expiry of five years from the year of allotment of ESOP
  2. Date of sale of the ESOP by the employee
  3. Date of termination of employment

How to calculate Fair Market Value of the Shares (FMV)

  • If the shares are traded on the recognised stock exchange on Exercise Date – FMV of the shares will Average of Opening & Closing Rate
  • If the shares are not traded on recognised stock exchange on Exercise Date – FMV of the shares will Closing Price of the shares on the date preceding Date of Exercise.
  • If the shares are unlisted – the Merchant Banker shall determine the FMV of the shares.
 

Second Tax Trigger - When ESOP's Are Sold - Capital Gains Tax will Apply

Taxability on Short-term or long-term capital gains

The rates at which your capital gains shall be taxed depends upon the period of holding of shares. The period of holding is calculated from the exercise date up to the date of sale.

For Listed Shares

Equity shares listed on a recognised stock exchange (where Securities Transaction Tax i.e. STT is paid on sale) are considered long-term gains when held for more than one year.

If sold within one year, they are considered as short-term gains.

For Unlisted Shares

Unlisted Equity shares are considered as long-term when held for more than two years.

If sold within two years, they are considered as short-term gains.

 

Taxation of Capital Gains

Type of Shares

Period of Holding

Capital Gains

Tax Rate

Listed Shares

Less than or equal to 12 Months

Short Term Capital gains u/s 111A

15%

Greater than 12 months

Long Term Capital Gains u/s 112A

10% in excess of Rs.1 Lakh

Unlisted Shares

Less than or equal to 24 Months

Short Term Capital gains

As per Income Tax Slab rate of the Employee

Greater than 24 months

Long Term Capital Gains u/s 112

20% without Indexation

Taxation of Loss on sale of Shares under ESOP

  • Long Term Capital Loss on sale of Listed or Unlisted shares can set off against Long term Capital Gains and can be carry forward for a period of 8 years.
  • Short Term Capital Loss on sale of Listed or Unlisted shares can set off against both Long term Capital Gains or Short Term Capital Gains and can be carry forward for a period of 8 years.

Disclosures under Income Tax Return

Several disclosures have been added in income tax return forms for foreign assets held. If you own ESOP's of a foreign company, you may have to disclose your foreign holdings under schedule FA of your income tax return. These disclosure requirements are applicable to a resident taxpayer.

Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement

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