Taxation on Employee Stock Option Plan
What is ESOP
Section 2(37) of Companies Act, 2013 defines “employees stock option” which means, ‘the option given to the directors, officers or employees of the company or of its holding or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at pre-determined price.’
How is ESOP beneficial for an Employee
Employee Stock Option Plan are offered by the companies to their employees as a benefit scheme. Employees get the reward for hard work in the form of equity rather than cash. They get option to buy the company’s shares at a lower price after a predetermined vesting period i.e. minimum 1 year.
How is ESOP beneficial for Company
ESOP attracts and retains talents it also improves employee’s morale and productivity. It reduces employee turnover, which provides a greater job security and better employee retention. It increases cash flow by making plan contributions in stock instead of cash.
Tax implication of ESOP
A) For the Employee
- 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”.
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)
- 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.
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.
- Period Of Holding – 25/02/2022 to 20/01/2023 i.e. less than 12 months
- 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).
- Tax Rate – The applicable tax rate for STCG is 15% under Section 111A
- Capital Gain per share = Sales Price – FMV = 80 – 50 = INR 30 per share
- Total Capital Gains = 1000 shares * 30 per share = INR 30,000
- 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
- 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.
- 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.
However, Union Budget 2019 made the same section applicable to the Listed Company as well. Provided it is effective on all buyback of shares after July 5th, 2019.
Hence Section 115QA is applicable to both listed and unlisted companies.
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