Taxation on Employee Stock Option Plan

Tax implication of ESOP

A) For the Employee

1. At the time of exercise (Prerequisite) – Upon allotment of shares after the employee exercises his/her option on the completion of the vesting period.

The difference between the fair market value (FMV) of shares on the date of exercise and exercise price of shares at the time of grant is taxed in the hands of the employee under the head “income from salary”.

Example

Mr. A received 1000 shares at INR 20 per share. The FMV of such shares are INR 55 per share.

Tax implications on the above transaction:

Purchase Price : INR 20

Fair Market Value : INR 55

Perquisite : INR 35 (55-20)

Taxable Amount : INR 35,000 (1000*35)

2. At the time of sale by the employee (Capital Gain) – When the employee sells these shares, a tax event happens. The difference between the Sale Price and FMV on the exercise date is taxed under the head “Capital Gains” as a short-term capital gain or long-term capital gain depending on the time period of holding.

Example

Mr A works for a company listed on NSE Ltd. He received 1000 shares from his company under the ESOPs scheme in FY 2021-22. And he sells the shares on 20/01/2023.

Date of Exercising the ESOPs i.e. Purchasing Shares: 25/02/2022

Fair Market Value as on 25/02/2022: INR 50

Sales Price as on 20/01/2023: INR 80

Tax treatment and calculation of tax liability for Mr. A:

Mr. A is required to pay tax on Capital Gains in FY 2022-23 on the sale of shares.

1. Period Of Holding – 25/02/2022 to 20/01/2023 i.e. less than 12 months
2. Type of Capital Gain – Since the shares are of a company listed on a recognized stock exchange in India and the period of holding is less than 12 months, it is a Short Term Capital Gain (STCG).
3. Tax Rate – The applicable tax rate for STCG is 15% under Section 111A
4. Capital Gain per share = Sales Price – FMV = 80 – 50 = INR 30 per share
5. Total Capital Gains = 1000 shares * 30 per share = INR 30,000
6. Tax Liability = INR 30,000 * 15% = INR 4,500

Inter country taxation of ESOP

The tax treatment for ESOPs given by foreign entities is similar to how the ESOPs from Indian entities are taxed, even employees of Indian companies often receive ESOPs from overseas parent companies, this does not change the allocation of tax treatment.

It may also be taxed in the country in which the shares are listed or the company is headquartered. In that case, refund can also be claimed. If applicable, benefits under DTAA (Double Taxation Avoidance Agreement) can be claimed.

The period of holding is 24 months on foreign shares for the purpose of the tax. Short-term gains are taxed at slab rates, while long-term gains are taxed at 20% with indexation benefit.

B) For the Company

1. The Issuing Company can claim ESOP’s cost as a deduction, the discounts under the ESOP are an employee cost and is to be allowed as a deduction over the vesting period, in the hands of the issuing company.
2. When ESOP shares are bought back by the Company and if any income arises to a shareholder on account of buy back shall be exempted in the hands of such shareholders. As per section 115QA, tax @ 20% shall be paid by the unlisted company on the buyback of shares.