Taxation for ESOPs
equity management software
Taxation for ESOPs

ESOPs are becoming very common in India, especially in the current scenario where a lot of start-ups are coming into the market and hiring the best talents with limited funds. The Company and the Employees both have the same interests and goals resulting in better results with fewer organizational conflicts. In other words, we can also say that ESOPs provide an opportunity for the Employees to be part owners of the organization after the vested options get exercised and converted to shares of the Company.

Let us talk about the TAXATION related to ESOPs the amount you should be ready with at the time of Exercising the Options and arising of Tax Events

There are two events of taxation in the ESOP lifecycle, one at the time of exercise of the options and another at the time of selling the shares.

1. Taxation at the time of Exercise

When the employee exercises the option, the difference between the FMV (Fair Market Value on exercise date) and Exercise Price is taxed as a prerequisite. The employer deducts TDS on this prerequisite. This amount is shown in the employee’s Form 16 and included as part of Total Income (Salary). For example - An employee has exercised 100 Options (1:1) into equity shares by paying the exercise price of INR 50 per share and the FMV of the share at the time of exercise is INR 550 per share.

Perquisite Income = INR 50,000 {100*(INR 550 - INR 50)}

Tax Rates = As per the income tax slab rate applicable for Income from Salary (as per Income Range)

Understanding the advantages of having a start-up registration: One of the major drawbacks for employees of start-ups is that they are liable to pay tax at the time when ESOPs are exercised which means a taxability event arises before the ESOPs are liquidated. In lieu of this, the Finance Act 2020 provided some relief in the form of deferring the taxation of ESOPs. Accordingly, the prerequisite tax on ESOP for employees of start-ups having DPIIT registration is required to be paid after the expiry of 5 years (whichever is earlier)

  • From the end of the relevant financial year in which shares are allotted;
  • or From the date of the sale of such shares by the employee; or
  • From the date on which the employee ceases to be the employee of the start-up

In the Budget 2020 Amendment, (w.e.f FY 2020-21), any employee who receives ESOPs from an Eligible Start-Up is not required to pay the perquisite tax in the year of exercising the option. The TDS on the “Perquisite Income” is deferred as per the below event (whichever is early):

  • Expiry of 5 years from the Grant Date or year of allotment of options (ESOPs)
  • Date of sale of the Employee stock options by the employee
  • Date of termination of employment.

2. Taxation at the time of selling the Equity Shares (Capital Gain)

When the employee sells the shares after exercising the options (and thus converting the same into equity shares) another tax event happens. The difference between the Selling Price and FMV on the date of exercise is taxed as capital gains.

(Selling Price - FMV) X No of ESOPs Exercised X Tax Rate as per Capital Gain Taxation

STCG- @15% on Capital Gain (Listed Shares) or Regular Income Tax Slab (Unlisted Shares)

LTCG- for Listed Shares @10% without Indexation where Gains are in excess of INR 1 Lacs & for Unlisted Shares @20% without Indexation Benefits.

Decoding the same as below:-

Perquisite Tax = Tax % * (FMV - Exercise Price)

Capital Gain Tax = Tax % * (Selling Price - FMV)

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