ESOP refers to an option given to employees of a company to purchase shares of the company, in return of his dedicated services to the company, at a future date at a pre-determined price. Employees have to wait for a certain duration before they can exercise the right to purchase the shares. This duration is termed as vesting period.
It is a frequently used incentive system practiced by many organizations. It has been majorly used by start-up Firms. It is a common practice among organizations to reward employees excelling at their work by giving ESOPs as a part of the salary and ensure their long-term commitment towards the company.
ESOPs are normally given at a price which is less than the market price of the share of firm. Since most organizations have now made ESOP an integral component of the total CTC for an employee, it is essential to understand how ESOPs in India are going to be taxed. Majority of the employees assume that they don’t need to pay any tax when the ESOP shares are sold, since tax has already been deducted and deposited by their organization.
Taxability of ESOPs
According to the amended provisions of Sections 17 (2) (vi) and 49 (2AA) of the Income Tax Act of India, taxation of ESOPs is done twice.
First, when an employee exercises his right for shares it is treated as a perquisite. When an employee exercises his option i.e. he wants to buy shares, the same are credited to his demat account. The Exercise Price (EP) at which an employee purchase the shares is lesser than their Fair Market Value (FMV) on the allotment date, sothe difference between fair market value and exercised price is treated as perquisite and taxed. This is reflected in Form 16 and Form12 B and treated as income from salary in the tax return.
Second, when an employee sells shares, the proceeds from this sale are treated as capital gain. If the company is listed on an Indian stock exchange and shares are held for more than 12 months by the employee it will be considered as long-term capital gain and as per the latest tax regulations it will be taxed at 10%. If shares are held for less than 12 months, it will be considered as short-term capital gain and profit will be taxed at 15%.
These days start-ups and unlisted companies, the shares of which are not listed on the stock exchanges are also allotting ESOPs to their employees. These shares will be considered short-term assets if held for less than 24 months from the exercise date. If the shares are held for more than 24 months, and sold after this period, these are considered as long-term assets.
If the employee is selling shares in less than 24 months, income will be added to his taxable salary and tax levied would be according to the respective tax slab. If shares are sold after 24 months, then it would be considered as long-term capital gain taxed at 20% after indexation of cost.
It is good to own the shares and its better to also know what would be your net receivable in hand after taking into account the tax implications. In this our tax advisors having expertize in ESOPs taxation can guide you.