Employee Stock Option Plan (ESOP) Taxation In India
What is ESOP?
ESOP is an abbreviation of Employee Stock Ownership Plan and an extensive employee benefit that is awarded to upper-level executives by companies and start-ups. The employees are offered shares of the company they are working in, for free or at a discounted price, at a predetermined price.
Why are ESOPs Given?
It is majorly a motivational and retention tool for employees who hold key managerial posts, giving them an economic benefit to staying vested in the company.
The rationale behind awarding ESOP is to attract new talent, retain old ones; provides a reason to stay long-term, promotes loyalty, and motivates to walk that extra mile!
What Benefits It carries?
From the employees’ point of view there are numerous benefits:
- Brings about the financial well being
- Works as retirement savings
- Gives immense job satisfaction along with security
- Provides social security
- Enhances trust in the firm and its management
- Improves overall well being
What Compliances are Mandatory For ESOP?
There are lot many legal and corporate compliances attached to ESOPs that have to adhere. Be it Companies Act, 2013, or Income Tax Act, or SEBI or FEMA, there is some compliance to be kept in mind.
How is ESOP Taxed?
There is two-tier taxation on ESOPs as mandated by the Income Tax Act, 1961, and enumerated in Sections 17 (2) (vi) and 49 (2AA).
First Stage of Taxation:
The first instance of tax is set off when the employee exercises his option and the shares are allotted to him. The Fair Value Price (FVP) of the shares and the exercise value are taken together and the difference that comes out is added to the salary of the employee and treated as taxable. The company is liable to deduct tax after computing the benefit to the salary slab.
The FVP is determined to depend on the fact that whether the shares are of a listed company in India or not. If it belongs to a listed company, then, the FMV is determined by taking out the average of the opening price and the closing price on that particular date. In case, the stock is not listed in India, then the FVP is calculated and determined by a merchant banker on a specific date, and who is registered with the Securities and Exchange Board of India.
So, in a way, we can conclusively say that ESOPs bring around monetary gains even when they are purchased!
Second Stage of Taxation For Listed Shares:
The second time ESOP attracts taxation when the allotted shares are sold off by the employee. In this scenario, the profit coming out of it is taxed as capital gains depending on whether it falls in the category of long-term or short-term capital gains.
If the shares belong to a listed company, then holding them for a period less than 12 months, shall attract short-term capital gains and will be taxable at the rate of 15%. On the other hand, if the shares are held for more than 12 months then, they will be deemed as long-term capital gains. Furthermore, if the amount is less than one lakh, then no tax shall be levied. In case the amount is more than one lakh then the tax shall be levied at 10% without indexation benefit.
Second Stage of Taxation For Unlisted Shares:
In case the share is of an unlisted company, it shall be considered long-term capital gains when held for more than 24 months, and deemed to be short-term capital gains if held for less than that.
“Phantom Stocks can trump over real stock as Phantom stocks have lots of flexibility & are not tied up in compliances & taxations like Employee Stock Ownership Plans.”
– Shweta Gupta, Founder, and CEO, MUDS