Taxability of ESOPs:
1. Meaning of ESOPs: As per Section 2(37) of Companies Act, 2013 “employees stock option” means, the option given to the employees including directors to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.
2. Taxability as a perquisite:
When an employee exercises the option to buy shares at a discounted price, it is treated as a perquisite under Section 17(2)(vi) of the Income Tax Act.
3. Tax Calculation of Perquisite Value = (Fair Market Value (FMV) on exercise date – Exercise Price) × No. of Shares
4. FMV as per Rule 3 of Income Tax Rules:
Listed companies:
Where the company is listed on the recognized stock exchange of India Average of the opening price and closing price of the share on the date of the said stock exchange is the FMV.
Unlisted companies:
Where the share in the company is not listed on a recognized stock exchange value of the share in the company as determined by a merchant banker on the specified date (date of exercise of option or any date not more than 180 days earlier than the date of the exercising.
5. Taxability: The perquisite value is taxed as part of salary income. The exercise of the option is the first taxable event in the hands of employees.
6. TDS Applicability: The employer is required to deduct tax at source (TDS) on this amount.
7. Taxability at the time of further sale:
When the employee sells the shares, any gains are taxed as capital gains, with the sale price minus the FMV at the time of exercise determining the taxable amount.
8. Deductibility of ESOP expenses by employer:
Hon Karnataka High Court in Commissioner of Income Tax v. Biocon Ltd. (ITA No. 653 of 2013), has held that:
Deduction under Section 37(1) of the Income Tax Act is permissible when the expenditure is incurred, even if the pay-out or expenditure is not incurred in cash.
Further, the HC held that expression ‘expenditure’ under Section 37(1) includes a loss and, therefore, covers discount on issuance of shares (due to the difference between the issue price and the market price) within its ambit.
