Employee Stock Option Plan (ESOP): Concept & Taxation


Employee Stock Option Plan (ESOP): Concept & Taxation

The biggest assets of any organisation are its human resources. Retaining & Rewarding is now one of the greatest challenges for the businesses. It’s all more relevant in case of new technological startups which cannot afford to pay high salaries during the initial phase of existence & survival. Employee Stock Option Plan (ESOP) could be one of the probable alternatives in few such cases. Recently, few companies have used it for their employees in lieu of pay cuts due to covid-19 pandemic. Various emerging startups can use it as a tool of motivation, promoting a sense of belongingness and ownership amongst the employees.

What is ESOP:
An ESOP is a kind of employee benefit plan wherein a right is offered to an employee to purchase the company’s shares at a present or future date at a free or at concessional rates. It often results in rewarding the employee with the development & growth in the value of the companies. With ESOP, employees are able to get a handsome amount of profit/revenue from the employer company. Since the employee is given just an option without any obligation attached to it, it is not mandatory for the employee to exercise the option. As far as ESOP is concerned, one needs to know few of the following terminology:

Vesting Date:Vesting date is the date on which the employee becomes entitled to buy shares.

Exercise Price:Exercise price is the price at which the employee buys the shares. This price is normally lower than the prevailing FMV (Fair Market Value) of the share

Exercise Period:After vesting, an employee gets the right to buy the ESOPs during a certain period of time. This is the exercise period

ESOP could be designed so as to offer it to senior executives only or only to those employees who complete certain tenure of service in the company. Companies can offer stocks to employees in a phased manner as well. ESOP enables companies to get & retain the manpower without paying higher salaries or direct incentives. Employees are able to share the future prosperity of the employer Company. ESOP helps in improving the company performance and thereby increasing the value of the shares. ESOP could be a good way to increase the capital of the company & offer the benefit to its human resources as employees can increase their wealth much faster than when they are earning just a normal salary.

 Taxation of ESOP:

ESOP has a typical taxable structure & it is taxable at two points of time:

  1. First, as perquisite at the time of exercise of option &
  2. Second, at a time when the employee sells the ESOP shares


Tax implication at the time of exercise of Option:

Tax incidence arises only when the employee exercises ESOP. There is no tax implication during the vesting period. On exercise of the option, if the Fair Market Value (FMV) of the share is more than the exercised price then the difference is taxable as “Perquisite”. The value of the shares allotted to the employee shall be the average of market price (average of highest and lowest price) on the date the option is exercised in case the shares are listed on any stock exchange in India. In case the shares are not listed the FMV of the same shall be as per the valuation certificate obtained from the merchant banker. The certificate of valuation of shares should not be older than 180 days from the date of exercise of the option. Even if the shares are listed outside India, the Company will have to obtain the certificate from Merchant Banker as such shares are treated as unlisted shares for ESOP purposes.

Since exercise of option requires payment of tax, Finance Act- 2020 has given some relaxation by deferring the Taxation of ESOP issued by an eligible start-up to its employees. Tax on the perquisite value arising from ESOPs shall be deferred only if the employer is an eligible start-up & shall be taxable at the earlier of following events –

  1. After expiry of 4 years from the end of the year in which shares are allotted; or
  2. Sale of stock option by the employee
  3. Resignation by the employee

The employer will be required to deduct and remit taxes within 14 days of the happening of any of the aforesaid events. Though the taxable timing has been deferred, the taxes will have to be computed at the tax rate applicable for the employee in the year of allotment. As a result, there will be neither benefit nor loss on account of change in tax rates.

Tax implications at the time of Sale:

The decision to sell the shares acquired under ESOP is like any other investment decision. Whenever the employee sells the shares acquired through ESOP, there will be a liability to pay the capital gains tax on the employee. The capital gain could be Short Term Capital Gain (STCG) or Long Term Capital Gain (LTCG) depending upon the period of holding. The holding period requirements are different for listed shares as well as for unlisted shares. The listed shares shall become long term if held for more than one year. For unlisted shares the same shall become long term after 24 months.

  1. For Listed shares (STT Paid):
    If ESOPs are held for a period of less than 12 month, the gains made on the listed shares will be treated as a STCG and will be taxed @ 15% [Section 111A]. However, if ESOPs are sold after completion of a period of 12 months, the gains on the listed shares will be treated as LTCG. The gains above ₹1 lakh will be taxed at 10% whereas gains up to ₹1 lakh are not taxable [Section 112A].
  2. For Unlisted shares:
    In case of unlisted shares, gains made on shares held for a period of over 24 months are treated as LTCG and are taxable @ 20% with indexation benefit. However, if the holding period of unlisted shares is less than 24 months, the gains will be treated as STCG & will be subject to tax at applicable tax slab rate of the employee.


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