Income Tax 11 Feb,2020
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How the TDS liability will be deferred in new system of ESOPs taxation?
DIPEN MITTALManager - R & D, Taxmann

The Finance Bill 2020 has proposed to change the system of taxation in respect of perquisite arising from ESOPs. Under the new system, employees of eligible start-ups would be able to defer their tax liability in respect of ESOPs to subsequent years. Consequently, employer shall be liable to deduct tax on ESOPs in subsequent year and not in the year in which share are allotted to employees under ESOP.

At present, when an employer allots shares to his employees under ESOP then the difference between the fair market value of shares on the date of exercising the option and the amount actually paid by the employee for such shares is taxable as perquisite under section 17(2)(vi) of the Income-tax Act and, consequently, employer is liable to include such perquisite in salary income of the employee and deduct tax thereon in the same year, i.e., the year in which shares are allotted.

However, as employees do not get any immediate benefit from the shares allotted under the ESOPs, the deduction of tax thereon in the year of allotment itself was very burdensome for them as it reduces the cash flow in their hand. Thus, in order to provide relief to employees of start-ups eligible for deduction under section 80-IAC, it is proposed to provide that the employer would be liable to deduct tax from income arising in the nature of perquisites from ESOPs within 14 days from the happening of any the following events (whichever is earlier):

a) On the expiry of 48 months from the end of Assessment year in which shares are allotted under ESOPs;

b) From the date the assessee ceases to be the employee of the organization; or

c) From the date of sale of shares allotted under ESOP.

For this purpose, the tax shall be deducted on the basis of rates in force for the financial year in which shares are allotted or transferred under ESOPs.

A similar amendment has been proposed to section 191 and section 156 to provide that if an employer does not deduct tax on perquisites arising from ESOPs then tax shall be payable by the employee directly within aforesaid period either voluntary or in response to a notice of demand.

But, interestingly, no amendment is proposed under section 17(2)(vi) which provides for chargeability of perquisite arising from ESOPs under the head "salary". Thus, perquisite arising from ESOPs shall be treated as income of an employee of the year in which shares are allotted but no tax would be required to be deducted or paid in that respect by the employer and employee, respectively. But, how this will be achieved is not clear as no mechanism is provided by the Government for deferment of TDS or tax payment on ESOPs.

One of the recommended mechanisms that will be the most appropriate one in such cases can be explained with the help of the following example:

Mr. A, working in a start-up company, has been allotted 100,000 shares at the rate of Rs. 10 per share under ESOP scheme in the Financial Year 2020-21. The fair market value of shares at the time of exercising of option by Mr. A is Rs. 100. Thus, the perquisite value of ESOPs taxable in the hands of Mr. A comes at Rs. 90 Lakhs [100,000 shares* (Rs. 100 - Rs. 10)]. The annual salary of Mr. A (excluding perquisite value of ESOPs) in that year is Rs. 40 Lakhs. He continues with the company even after expiry of 48 months from the end of the assessment year in which shares are allotted and he does not sell the shares even after expiry of said period. What shall be the mechanism for deferment of TDS and tax on perquisite value of ESOPs in such a case?

Assessment Year 2021-22

Mr. A would be required to disclose the perquisite value of ESOPs, i.e., Rs. 90 lakh in his return of income but he shall not be liable to pay any tax thereon in such year. The total tax liability for that year should be computed only on his annual salary of Rs. 40 lakh which shall be as follows:

Tax liability for Financial Year 2020-21 without including perquisite value of ESOPs under total income

Particulars Amount (in Rs.)
Total Income 40,00,000
Tax on Rs. 40 lakh as per slab rates applicable for Assessment Year 2021-22 as per old taxation regime 10,12,500
Add: Education Cess 40,500
Total Tax Liability 10,53,000

Assessment Year 2025-26

As Mr. A continues with the company even after expiry of 48 months from the end of the Assessment Year in which shares are allotted and he doesn't sell the shares even after expiry of said period, the liability to deduct tax or make payment of tax on perquisite value of ESOP will arise in the Assessment Year 2025-26, i.e., 48 months from the end of the Assessment year (2021-22) in which shares are allotted.

For the purpose of computing the tax liability in respect of perquisite value of ESOPs, the tax liability for Assessment Year 2021-22 shall be recomputed by including the amount of perquisite in total income, and, accordingly, the differential amount would be required to be declared in Assessment Year 2025-26.

Tax liability for Assessment Year 2020-21 after including perquisite value of ESOPs under total income

Particulars Amount (in Rs.)
Total Income before including perquisite value of ESOPs 40,00,000
Add: Perquisite Value of ESOPs 90,00,000
Total Income after including perquisite value of ESOPs 1,30,00,000
Tax on Rs. 1.30 crores as per slab rates applicable for Assessment Year 2021-22 as per old taxation regime 37,12,500
Add: Surcharge 5,56,875
Add: Education Cess 1,70,775
Total tax liability for Assessment Year 2021-22 after considering perquisite value of ESOPs 44,40,150
Less: Tax already paid at the time of filing of return for the Assessment Year 2021-22 10,53,000
Differential amount to be deducted or paid by the employer or employee in the Assessment Year 2025-26 33,87,150

In this regard, the Government may also amend the Income-tax return forms and include an additional field to show tax on perquisite value of ESOPs under Part B TI- TTI and, accordingly, tax deducted by employer shall be adjusted from such tax and if there is any shortfall then tax shall be required to be paid by the employee.

Further, the following information may be asked in income-tax return forms in respect of ESOPs:-

a) Date of exercising of option

b) Amount at which ESOPs were allotted

c) Fair market value of ESOPs on the date of exercising such option

d) Number of shares allotted under ESOPs

e) Date of allotment of shares

f) Income in the nature of perquisite arising from allotment of shares under ESOP (to be computed automatically)