What are ESOPs & its taxation

Nowadays, many companies, including local & international and even start-ups offer ESOPs to attract, retain and reward their employees.

What are ESOPs?

Employee Stock Option Plan (ESOP) is an employee benefit plan provided by the employer to the employee. It aims to incentivize employees over a period of time and benefit from the company’s growth by offering them an ownership interest in the company they are working in.

It allows the employees to buy the company’s stock at a pre-determined price, usually below the market price. The shares remain in an ESOP trust fund until the vesting period and till the option holders exercise their rights.

Before we dive in, let’s understand a few key terms:

  1. Vesting date: The date on which the employee is entitled to buy shares
  2. Grant date: The date of the agreement between employer and employee to grant an option to the employee to own shares of the company
  3. Vesting period: The period between the grant date and the vesting date
  4. Exercise Period: The period when the employee has a right to buy the shares after the stocks are vested
  5. Exercise Date: The date on which the employee exercises the option
  6. Exercise Price: The price at which the employee exercises the option

Why ESOPs?

Employer: Often, companies lack liquid funds and hence cannot compensate their employees well. Yet, they raise the value of their salary package by providing a stake in their company.

Employee: With ESOPs, an employee gets a stake in the company at a discounted rate, sells the stocks (after a defined period set by the employer), and makes a profit.

Considering so many steps involved in the implementation of ESOPs, it is essential to understand the taxation aspect of the same.

Taxation of ESOP

ESOPs are taxed in 2 instances:

  1. At the time of exercise - as a perquisite under income from Salary
  • The time when an employee exercises the option, the difference between the FMV of the shares (on the exercise date) and the exercise price paid by the employee is taxed as a perquisite u/s 17(2) of the Income Tax Act at slab rates. This amount is also shown in Form 16, forming a part of Salary income.

Note: In the budget 2020, the FM made an amendment as below:

An employee receiving ESOP from an eligible startup is exempt from paying tax at the time of exercising the option from FY 2020-21 and tax is to be paid at the time of redemption. Read about it here.

  1. At the time of sale - under income from Capital Gains
  • When an employee decides to sell the shares, the difference between the FMV of the shares (on the exercise date) and the sale price (after taking into account the indexed cost of acquisition) is taxed as a capital gain. The employee must report it as Capital Gains in the ITR and pay tax on such income at the applicable rates below:

Few other considerations:

  1. What if there is a loss?

In case of a loss, it can be carried forward and set off against capital gains in the future.

  1. Residential Status:

If you are an NRI, there might be chances of exercising an option or selling shares, and you may have to pay tax outside of India. In such a case, you may be able to take benefit of the Double Taxation Avoidance Agreement (DTAA). It makes sure your income is not taxed twice.

  1. When the option is not exercised?

On the vesting date, the employee gains a right to exercise his option or buy the stocks. But there is no obligation, meaning, the employee can choose to not exercise his option. In such a case there shall be no tax implication for the employee.

  1. Advance tax

Since this is taxable income, you must calculate the tax liability and pay Advance Tax to avoid interest and penalty
Use this to calculate and pay advance tax - Advance Tax Calculator

Read more about ESOPs Taxation in the hands of an Employee - Learn by Quicko
Have questions? Shoot’em.

Hi, Assume I applied for 1 share of X company for 100rs. on ESOP and i have paid tax(TDS) as 31.2 Rs. .Now after 1 year the price of the share is 50rs. how can I get refund of excess tax paid 15.6rs. now.Pls reply

Hi @Deeban_Thangavelu

The difference between the cost of acquisition and the sale price is your capital loss or capital gains.
This is reported under the head of “Income from Capital Gains”.
When reporting income under this head, you can claim only certain expenses. As per the law, any tax paid (TDS) cannot be claimed as an expense.

In your case, if the share price falls to ₹50 from ₹100, then there is a capital loss (long term loss or short-term loss, depending upon the holding period). This capital loss can be set off and carried forward.

So is it correct to assume I am taxed twice? First when I exercise I am taxed the perquisite tax, and then assuming the share price is up, a capital gain tax?

Hi @Tanuj_Joshi

Yes, ESOPs are taxed in 2 instances as correctly mentioned by you.

When you sell those shares, you can reduce the capital gains by the amount of the cost of the acquisition of those shares.

Hi I would like to know how is ESOP liquidation taxed? My wife has been notified by her employer about ESOP liquidation. So would like to know what’s percentage that gets taxed? Will the employer TDS and share the amount?

Hi @Jayadev_Nair

You can read about the ESOPs Taxation in the hands of an Employee - Learn by Quicko.

Hi @Shrutika_Shah ,
First of all your article was a nice read. There is not much info available on ESOPs and their taxation. I have a question about unlisted shares becoming listed.

Let’s say I have 1 ESOP that has and excercise price of 10 Rs and FMV of 100 at the time of exercise.
Tax liability = (100-10)*0.3 (Assuming tax slab to be 30% and not taking in account for cess for the calcualtion) = 27
I pay 10(ExercisePrice) + 27(Tax) = 37Rs and I am given a share cetificate for 1 share of the unilsted company,
Let’s say I exercise it on 1 Jan 2024 and am granted the share on the same day as well (Ignoring 30-60 day grace period between the actual grant).

Now let’s say on 1 Oct 2024 the company beomes listed. How will that affect my taxation?

LTCG % of unlisted and listed shares is different and also the time duration is also different for change from STCG to LTCG.
As I have been holding the share since 1 Jan 2024 and on 2 Jan 2024 it is a listed share, can I sell it on 2 Jan 2024 and just pay 10% LTCG or there is someting else that takes place when the comany goes through IPO?
For the sake of values let’s say the initial listing price is 200Rs and the rate at 2 Jan 2024 is 250Rs if we want to make use of these values.

P.S. Thanks in advance. I am currently working with a start up and thinking of exercising my ESOPs so that I can decrease my net tax liability on these and am in the process of exercising them. Would be really helpful to gain the info on the above example as well.

Hi @Shrutika_Shah

My company offered me a one time payment to not exercise my ESOPs. At the time of payment, I had not been employed by the company for a long time. Under which head would this income come under and how will it be taxed?

Hey @Anish_Sharma,

I am in touch with my team for this query and will get back to you with the answer.

Hey @Lokesh,

Such one-time payment can be reported as “Profit in lieu of Salary” while filing the ITR. It will be taxed as ‘income from salary’.

Hope this clarifies!

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