Taxation of ESOPs in India: A Comprehensive Guide
Sandesh Jaiman
Chartered accountant and Personal finance enthusiast,Building Six Sigma Finserv.
The writer can be reached at: sixsigmafinserv@gmail.com
Employee Stock Option Plans (ESOPs) have become a popular way for companies to reward and retain employees by offering them a stake in the organization. However, ESOPs come with tax implications at two stages—when the shares are allotted and when they are sold. Understanding the taxation structure is crucial for employees to plan their finances efficiently.
1.Taxation at the Time of Exercising ESOPs
When an employee is granted ESOPs, they are not subject to tax. However, taxation occurs when the employee exercises the option to purchase shares. The tax is levied on the difference between:
- The fair market value of shares on the exercise date and the amount paid by the employee for ESOPs
This difference is considered a perquisite under salary income and is taxed as per the employee’s applicable income tax slab. Since it forms part of the salary, it also attracts TDS (Tax Deducted at Source) from the employer.
2. Taxation on the Sale of Shares (Capital Gains Tax)
Once the employee exercises the ESOPs and becomes the legal owner of the shares, they may decide to sell them in the future. The taxation on capital gains depends on two factors:
- The holding period (i.e., the duration for which the employee holds the shares before selling).
- Whether the company is listed or unlisted in India.
A. If the company is not listed in India
For unlisted companies, the holding period determines the nature of capital gains:
- Long-Term Capital Gains (LTCG): If the shares are held for more than 24 months, the gains are subject to a tax rate of 20% after indexation benefits.
- Short-Term Capital Gains (STCG): If the shares are held for less than 24 months, the gains are taxed as per the employee’s income tax slab rate.
B. If the company is listed in India
For listed companies, the taxation structure differs:
- Long-Term Capital Gains (LTCG): If the shares are held for more than 12 months, they are taxed at 12.5%, with an exemption available for gains up to ₹1,25,000.
- Short-Term Capital Gains (STCG): If the shares are sold within 12 months, the gains attract a tax rate of 20%, and no exemption is available.
Summary of Tax Implications
| Stage | Tax Component | Tax Rate | Condition |
|---|---|---|---|
| Exercise of ESOPs | Salary Income (Perquisite) | As per the slab rate | FMV on exercise date minus the purchase price |
| Sale of Shares (Unlisted Company) | LTCG | 20% | Holding period is > 24 months |
| STCG | As per the slab rate | Holding period is < 24 months | |
| Sale of Shares (Listed Company) | LTCG | 12.5% | Holding period is > 12 months (exemption up to ₹1,25,000) |
| STCG | 20% | Holding period is < 12 months (no exemption) |
Conclusion
While ESOPs provide an excellent wealth-building opportunity for employees, they come with tax obligations at multiple stages. Proper tax planning, including a thorough understanding of the tax implications at the time of exercise and sale, can help employees maximize their benefits while ensuring compliance with tax laws.
A clear understanding of ESOP taxation allows employees to make informed decisions about when to exercise their options and sell their shares to minimize their tax liability. Consulting a tax professional can provide additional clarity and help with tax planning strategies.
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