How ESOPs are taxed in India?

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  • Last Updated on 29 January, 2021
ESOP or Employee Share Options Plan is the option that a company provides to its employees to purchase the company’s shares on future dates at a pre-determined price. It is popular these days and many a times part of salary offer given to newly hired executives.

How are taxes calculated on ESOP?

There can be two stages with respect to levy of tax on shares allotted under ESOP: 1. First levy occurs when shares are allotted to the employee after he has exercised his option on  completion of the vesting period and 2. Second levy occurs when the employee opts to sell the allotted shares under the ESOP. At the time of allotment of shares on the exercise date, the difference between fair market value of the shares as on exercise date and the amount that employee have paid for the exercise or subscription to the shares is calculated and taxed accordingly. This taxable value is called Perquisite value.  This difference calculated is eligible for TDS deduction by the company and forms part of salary of the employee which is shown in Form 16 and Form 12BA of the employee. When employee opts to sell the shares previously allotted under the ESOP,  profits made by him are taxed as capital gains earned during the year. These Capital Gains are calculated by subtracting the fair market value as on the exercise date from the sales consideration of such shares.

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How Capital Gains are calculated on ESOP?

When employee sells the shares which were allotted to him under ESOP, tax is levied on any amount of profits or gains arising from such transaction. Such profit is taxable under the head ‘Capital Gains’. Capital gains can further be classified as ‘Short Term Capital Gains’ and ‘Long Term Capital Gains’ depending upon the period of holding of such shares. In case of listed shares, if the holding period is more than 12 months, capital gains will be treated as Long-term capital gains and no tax will be levied if such capital gains doesn’t exceeds Rs. 1 lakh. However, in case the amount of capital gains is more than Rs. 1 lakh then tax shall be levied @ 10% without indexation benefit. If holding period is less than or equal to 12 months, then such gains will be treated as short-term capital gains & will be taxable @ 15%. In case of unlisted shares, gains will be treated as long-term if shares are held for more than 24 months. Tax will be levied @ 20% with indexation benefit and @10% without indexation benefit. If holding period of such shares is less than or equal to 24 months, gains will be treated as short-term and will be taxable as per slab rates of the taxpayers.

Example illustrating on how ESOP is taxed?

On July 1, 2014 X has been given an option under ESOP, to purchase 10,000 shares of ABC Ltd. The option can be exercised at the end of 3 years i.e. July 1, 2017 and the exercise price was fixed at Rs. 60. On July 1, 2017, at the time of allotment of shares of the company to X, the fair market price of the shares of ABC Ltd was Rs. 100. Now, he decides to sell the shares @ 120 each on January 31, 2018.

Taxability of these shares under ESOP

ESOP Taxation – while exercising the shares – Perquisite value of ESOP (on date of allotment) = (FMV per share – Exercise price per share) x number of shares allotted. (100-60) x 10,000 = 400,000 The amount calculated above as perquisite value of ESOP i.e. Rs. 4,00,000 shall form part of X’s salary and be taxable in the year of allotment of such shares. Employer is liable to deduct TDS on such amount. Such amount will be reflected in Form 16 and Form 12BA of X.

ESOP Taxation – At time of sale:

Capital gains = Sale proceeds – FMV of shares at the time of allotment of shares  (120 – 100) x 10,000 = Rs. 200,000 Since the holding period of shares in the hands of X is less than 12 months, gains will be classified as Short-term Capital Gains and will be taxable as per the normal slab rates applicable on X.

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