ESOPs Taxation

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ESOPS Taxation

A Win-Win game

Employee Stock Option Plan is nowadays one of the most lucrative & accepted compensation among the employees; it helps to retain talent & serves as a reward for past services. ESOP has a win-win situation on both sides; it gives employee ownership interest in the growth of company & employer can function it very well by retaining the true gems of organizations.

Basic Explainer

ESOP’s basically is an option granted to an eligible employee to purchase/subscribe to a specified number of shares on a future date, at a predetermined exercise price, upon fulfillment of the vesting period and other criteria defined by the organization. Once vested, an employee has the option of exercising such ESOP’s at a pre-agreed exercise price, which is generally marked at or lower than the prevalent Fair Market Value (FMV) of the organization’s shares on the date of the grant of the options. In case the ESOPs are underwater, i.e., the FMV as on the date of the exercise falls lower than the exercise price, then exercising the option may not be feasible for an employee.

So now, after having our basics clear, we would like to dip dive more to understand it from a taxation perspective.

One of the untouched point in ESOP’s

Tax in Esops are attracted at two stages as below,

ESOPS Taxation

At the first stage, the perquisite value is computed as the difference between the FMV of the share on the date of exercise and the exercise price. There are specific valuation rules prescribed for listed and unlisted entities. Unlisted entities (including foreign companies) need to determine the FMV by obtaining a valuation certificate from a Category I merchant banker registered with the Securities and Exchange Board of India (SEBI). The employer is required to withhold tax at source (TDS) in respect of such a prerequisite.

Second-stage taxation for listed shares, i.e. income from capital gains, is triggered at the time of subsequent sale of shares by an employee. This sale may be categorized as long-term or short-term in nature depending upon the period of holding from the date of allotment and tradability in a recognized stock exchange. Capital gains are computed as a difference between the sale consideration and the FMV as on the date of allotment of shares (which was already considered for the first stage of taxation). In the case of listed equity shares and units of equity-oriented mutual funds subject to Securities Transaction Tax (STT), if the holding period is less than 12 months, the gains would be categorized as short-term and taxed at a concessional rate of 15 per cent. If the period of holding exceeds 12 months, then the gains would be categorized as long-term and taxed at 10 per cent for value over Rs 1 lakh without indexation benefit. Such long-term gains were exempt from taxation before Financial Year 2018-19. However, such exemption was withdrawn in the Union Budget of 2018, and the gains were grandfathered up to January 31, 2018.

The second stage for Unlisted Shares, In the case of unlisted securities (including shares issued by foreign companies), the period of holding for categorizing short-term and long-term gains is 24 months, and such gains are taxable at the applicable slab rates, and 20 per cent with the indexation benefit (10 per cent without the indexation benefit), respectively.

Set off Gains & Losses, In case such a sale transaction results in capital loss, then it may be set off against other current year capital gains wherein short-term losses can be set off against short-term or long-term gains. Long-term losses, however, can be set off against long-term gains only. Unabsorbed capital losses, if any, may be carried forward to eight subsequent FYs for set-off as above.

In the case of migrating employees, the taxation of ESOPs poses its own unique challenges, but in a nutshell for migrating employees, based on the general principles of taxation, a proportionate amount relating to service rendered in India is income accrued in India and, hence, taxable irrespective of the residential status of the individual employee.

There are multiple other points we need to look on for ESOPs taxation like, (e.g., company law, accounting and FEMA) before organizations consider implementing an ESOP plan for their employees.

We want to work with you on your finances & arrange this all complex things from clutter to clarity.


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