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