ESOP are Employee Stock Option Plan & some called them – Employee Stock Ownership Plan. ESOPs have emerged as an important incentivizing option for employees. We have seen many employees becoming millionaires with these plans. So ESOP taxation becomes important to be understood & adhered to.
ESOPs being a financial scheme, involves taxation also. Rules are different for Indian Company, A Foreign Company & Unlisted Company. Well, as it is said – You cannot escape Death & Taxes. Unfortunately, the organization does not guide employees on ESOP taxation. But you are aware or not, you have to abide by rules of taxation for ESOPs.
So before we venture into the ESOP taxation part, let’s know:
What is ESOP?
It’s a right given to employees of a company to buy shares of the company at a fixed price on the date of the grant.
It’s generally given as a performance-based or completing a specified duration with a company. For Eg, HDFC Bank can have an ESOP scheme after an employee becomes a VP. So this motivates employees not to leave the job and strive hard for high ranking.
The company doesn’t offer all shares on a single day. Shares quantity is allotted to be vested at a different period. This period is called the vesting period.
COVID 19 Update Dated 18/06/2021:
Vesting Period Eased
☑️ SEBI relaxes holding period for vesting stock options post employee’s death in case of ESOPs
☑️ SEBI has waived the one-year cooling-off period for vesting of stock options after the death of the employee with ESOPs
☑️ The waiver shall be applicable for all employees who died on or after 1 April 2020
☑️ The move is expected to help the families of the deceased ESOP holders
For more details read: SEBI Circular
If the employee does not exercise the option of buying the shares within the vesting period, the options lapse and the employee does not get any rights.
Types of ESOPs
Employee Stock Option Scheme (ESOS) – It is the most commonly used. The option granted under the plan confers a right but not an obligation on the employee. Stock options are subject to vesting, requiring continued service over a specified period. Upon vesting of options, employees can exercise the options to get shares, by paying the pre-determined exercise price.
Employee Stock Purchase Plan (ESPP) – This plan allows employees to purchase companies shares often at a discounted price to its fair market value. The terms of the plan determine the tenure and price for possession of the Company’s shares by the Employees. Usually, ESPPs are being framed for offering shares as a part of public issues.
Stock Appreciation Rights (SARs) or Phantom Equity Plan- It provides employees with cash payments equal to the appreciation of the company’s stock over a specified duration. Hence, compared to other ESOPs, SARs provide employees with equity upside without exposure to any downside. SARs do not give equity or ownership permanently.
Restricted Stock Units (RSU) – In this plan an employee is awarded the right to receive shares on a pre-determined date subject to the occurrence of a specified event or fulfillment of specified conditions. RSU does not get transferred to the employee immediately, but in the future and certain cases, he/she may also be entitled to partial dividends.
How does ESOP Plan Work
Also if you want liquidity, ESOPs are not the best option as there are many rules regarding when to exercise your options.
There are also tax implications that should be considered carefully. Especially ESOPs taxation becomes trickier when issued by an unlisted or a foreign listed company.
Here is how ESOPs are taxed at various stages in India.
ESOP Taxation
There are generally two tax implications stages on Employee Stock Option Plan or ESOP Taxation
The first is when the employee exercises his/her right to buy the shares and the second when he/she is ready to sell the shares.
First Stage
When the employee chooses to exercise his option, the perquisite (perk) is added to his/her salary and is taxed by the employer.
Your employer must have deducted this as perk & the same must have reflected in form 16 of that year.
Perk = Fair Market Value – Exercise/Subscription Price
Second Stage
When employee Sales Shares
When an employee decides to sell his/her shares, he/she will be liable to capital gains tax.
Capital Gain is decided on 2 parameters:
- Is the share listed? Or Unlisted. If Listed, in India? Or Abroad?
- Holding Period of the investment.
If shares listed in India
Holding Period Less than 1 years: STCG
Holding Period Less than 1 years: LTCG
If shares Unlisted in India or listed in a non-Indian stock exchange
Holding Period Less than 2 years: STCG
Holding Period Less than 2 years: LTCG
(LTCG- long-term capital gain tax/ STCG- short term capital gain tax)
Tax Rates FY2020-21 for Listed Shares
STCG: 15%
LTCG: 10% (Over the Income of Rs 1 Lakhs)
Plus Applicable Surcharge &Cess.
Tax Rates FY2020-21 for Unlisted Shares
STCG: Added to Income (your tax slab)
LTCG: 20% with Indexation Benefit(Over the Income of Rs 1 Lakhs)
Plus Applicable Surcharge &Cess.
3 Important points-
- Even in case, STT has not been paid while buying the shares listed in India, the grandfathering benefit can not be availed on ESOPs. (Grandfathering)
- In case STT has not been paid while buying the unlisted shares or foreign listed shares, the grandfathering benefit can be availed on ESOPs. (Grandfathering)
- In case the foreign broker has deducted TDS / Withholding tax during the selling of shares, the same can be adjusted as per the Double Taxation Avoidance Agreement(DTAA).
I hope this clarifies ESOP Taxation in India. Use the comments section below for your queries or email me at madhupam at the rate thewealthwisher dot com.
Article Contribution: Kapil Kumar Shingari
