What are ESOPs?
ESOP meaning Employee Stock Ownership Plan is an employee benefit plan provided by an employer to its employees. ESOP allows an employee to buy a stock of their company at a below-market price. It also offers ownership interest to employees. A company may issue ESOPs in form of direct stock, profit-sharing plans, or bonus. Below is a brief process for issue of ESOPs:
- The company or employer decides to issue ESOPs
- The employee opts to exercise the ESOPs i.e. buy the shares
- The employee sells the shares
Before granting ESOPs to employees, an employer needs to follow rules and regulations relating to ESOPs as per the Companies Act 2013.
An employee needs to understand tax on ESOP before exercising the option. Below are the provisions for ESOP Taxation in the hands of an employee:
- At the time of exercising right i.e purchasing the shares,
- At the time of selling the shares.
Hence it is important to understand the tax implications of Employee Stock Options before filing ITR for the financial year on the income tax website.
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Tax Implications of ESOPs
It is important to understand ESOP taxation in India before the employer considers implementing an ESOP scheme.
ESOPs are taxed in the following two instances:
- At the time of exercising ESOP: It is considered as a Perquisite under the income head ‘Salary’. Hence, when an employee exercises his option, the difference between Fair Market Value (FMV) as on the date of exercise and the exercise price is taxable as a perquisite.
2. At the time of selling ESOP: It is considered a Capital Gain. An employee might sell his/her shares after buying them. In case he/she sells these shares at a price higher than FMV on the exercise date, he/she would be liable for capital gains tax.
ESOPs Taxation on Purchase of Shares
When an employee exercises the stock option i.e. agrees to buy the shares, it is a taxable income. The shares are credited to a Demat Account of an employee once shares are purchased. Here is the tax treatment for tax on purchase of shares under ESOP:
- The exercise of stock option is treated as a Perquisite under the income head ‘Salary’
- Perquisite amount is the difference between FMV as on exercise date and exercise price.
- Perquisite will be taxed in the year in which the employee exercises the ESOP
- The employer will deduct TDS on such amount and issue Form 16 to the employee
- The employee must report it as Salary Income in the ITR, claim TDS Credit and pay tax on such income at slab rates.
Example
Neha works in a startup in India. During FY 2021-22 her company announces ESOPs for all the current employees. Neha decides to exercise her option to buy the shares of the company. Under this scheme, Neha received 2000 shares at INR 20 per share. The FMV of the shares is INR 45 per share. Following are the tax implications on the above transaction.
Purchase Price: INR 20
FMV: INR 45
Perquisite: INR 45 (45-20)
Taxable Perquisite Amount: INR 90,000 (2000*45)
Now the company will treat INR 90,000 as a taxable salary and will deduct TDS on the same. While filing her ITR, Neha needs to report INR 90,000 as Perquisites under Salary Income Head.
Budget 2020 Amendment for ESOPs
Under Budget 2020, the finance minister announced to defer TDS or tax payment on shares allotted by startups to their employees under ESOPs. Thus, from FY 2020-21 onwards, when an employee receives ESOPs from an eligible startup, they need not pay tax in the year of exercising the option. The employer can defer the deduction of TDS on the perquisite amount up to the occurrence of the following events whichever is earlier:
- Expiry of 5 years from the year of allotment of ESOP
- Date of sale of ESOP by the employee
- Date of termination of the employment
ESOPs Taxation on Sale of Shares
When an employee sells the shares, it is treated as Capital Gains. Here is the tax treatment for tax on sale of shares under ESOP:
- The sale of shares is treated as capital gains
- Amount of Capital Gain is the difference in Sale Price and FMV as on the exercise date
- The period of holding is calculated from the exercise date up to the date of sale
- Capital Gains will be taxed in the financial year in which the employee sells the shares
- The employee must report it as Capital Gains in the ITR and pay tax on such income at applicable rates below
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Example
Arya is a salaried individual. She works for a company listed on NSE Ltd. She received 2000 shares from her company under the ESOPs scheme in FY 2020-21. And she sells the shares on 20/01/2022.
Date of Exercising the ESOPs i.e. Purchasing Shares: 25/02/2021
FMV as on 25/02/2021: INR 50
Sales Price as on 20/01/2022: INR 75
Below is the tax treatment and calculation of tax liability for Arya
Arya must pay tax on Capital Gains in FY 2021-22 on the sale of shares.
- Period Of Holding – 25/02/2021 to 20/01/2022 i.e. less than 12 months
- Type of Capital Gain – Since the shares are of a company listed on a recognised stock exchange in India and the period of holding is less than 12 months, it is a Short Term Capital Gain.
- Tax Rate – The applicable tax rate is 15% under Section 111A
- Capital Gain per share = Sales Price – FMV = 75 – 50 = INR 25 per share
- Total Capital Gains = 2000 shares * 25 per share = INR 50,000
- Tax Liability = INR 50,000 * 15% = INR 7,500
How to calculate FMV for ESOP?
Treatment of Loss from Sale of ESOPs
The loss on sale of shares received in form of ESOPs is a Capital Loss.
- The loss on sale of listed shares held for more than 12 months or unlisted shares held for more than 24 months is a Long Term Capital Loss. As per the income tax rules for set off and carry forward of losses, the taxpayer can set off Long Term Capital Loss (LTCL) against Long Term Capital Gain (LTCG) only. They can carry forward the remaining loss for 8 years and set off against LTCG only.
- The loss on sale of listed shares held for up to 12 months or unlisted shares held for up to 24 months is a Short Term Capital Loss. The taxpayer can set off Short Term Capital Loss (STCL) against both Short Term Capital Gain (STCG) and Long Term Capital Gain (LTCG). They can carry forward the remaining loss for 8 years and set off against STCG and LTCG only.
FAQs
Under which head of Income-tax is ESOP taxable and which ITR is to be filed?
-When an employee buys the shares of a company, it is treated as a Perquisite. And thus taxable under the head Salary. In this case, the taxpayer is required to file ITR-1.
-When an employee sells the shares, it is treated as Capital Gains and thus taxable under the Capital Gain head. In this case, the taxpayer is required to file ITR-2.
How do I report ESOPs i.e. employee stock options in my Income Tax Return?
The taxpayer must report perquisite under salary income on exercising the ESOP. Further, he/she must report it as Capital Gains on the sale of shares. If a taxpayer owns ESOPs/RSUs of a foreign company, they must report it as a foreign holding under Schedule FA i.e. Schedule Foreign Assets in the Income Tax Return.
Am I liable to pay Income Tax if I do not exercise the ESOP?
The employee has a right to exercise the ESOP on the exercise date. However, if the employee does not exercise the same, there is no tax implication on the same.
