INDEX
- Introduction
- Why ESOPs are Given
- Tax Implications of ESOPs
- Example
- ESOPs in Start-Ups (Tax Deferral for Eligible Start-Ups)
- Mechanism for Deferment of Tax
- Deferment in Subsequent Years
Taxation of Employee Stock Option Plan (ESOP)
Introduction
- ESOPs are securities offered to employees at a concessional rate or free of cost. They are taxable as a perquisite in the year they are allotted.
- Deferral of tax is allowed for employees of eligible start-ups is subject to specific criteria and conditions under Section 80-IAC and other applicable rules..
- Perquisite Value: The market value of securities on the exercise date minus the amount paid by the employee.
Why ESOPs are Given
- Retention Tool: Used by companies to retain talent, particularly in start-ups that cannot afford high salaries.
- Motivation: Employees feel responsible for company performance as they hold stakes in the company.
Tax Implications of ESOPs
- At the Time of Allotment:
- Tax is levied on the perquisite value, i.e., the difference between the Fair Market Value (FMV) at the time of exercise and the amount paid by the employee.
- This is treated as a salary perquisite.
- Fair Market Value (FMV) Calculation:
- Quoted Shares: Average of the opening and closing price on the exercise date.
- Unquoted Shares: Valued by a merchant banker on the exercise date or a date close to it (no more than 180 days earlier).
Example:
If shares are listed on multiple exchanges, FMV is determined based on the exchange with the highest volume of trading.
Example of Perquisite Calculation
- Granting Date: 01-Apr-2020
- Exercise Date: 10-May-2022
- FMV (31-Mar-2022): ₹6,000
- FMV (10-May-2022): ₹6,500
- Exercise Price: ₹500
- Number of Shares: 100
Perquisite Value = (₹6,500 – ₹500) * 100 = ₹6,00,000
At the Time of Sale or Transfer
- Capital Gains Tax: The difference between the sale price and the FMV at the time of exercise is taxed as capital gains.
- Holding Period: The holding period starts from the date of allotment, not the exercise date.
- Cost of Acquisition: FMV at the exercise date is considered.
ESOPs in Start-Ups (Tax Deferral for Eligible Start-Ups)
- For Eligible Start-Ups, tax on ESOP perquisites is deferred.
- Tax Deduction (TDS): Employers of eligible start-ups will defer the deduction until one of the following occurs:
- 48 months after the end of the assessment year in which shares were allotted.
- Employee leaves the company.
- Shares are sold by the employee.
- The employee must disclose the perquisite value in their return of income but will not pay tax in the year of allotment. Tax is deferred as per the rules.
Mechanism for Deferment of Tax
- Example (Mr. KUMAR):
- Shares Allotted: 100,000 shares at ₹10 each.
- FMV at Exercise: ₹100.
- Perquisite Value: ₹90,00,000 (100,000 * ₹90).
Tax Calculation for Assessment Year 2023-24:
- Salary (excluding ESOPs): ₹40,00,000
- Total Income (including ESOPs): ₹1,30,00,000
- Tax on ₹1.3 Cr: ₹37,12,500
- Surcharge & Cess: ₹7,27,650
- Total Tax: ₹44,40,150
- Tax Attributable to Salary Income (excluding ESOP): ₹13,66,200
- Tax on ESOPs: ₹30,73,950 (deferred to future years).
Deferment in Subsequent Years
- In 2027-28: Tax on ESOPs is due after 48 months from the end of the assessment year in which shares were allotted.
- Tax Computation:
- Tax Already Paid: ₹13,66,200.
- Tax Payable on ESOPs: ₹30,73,950.
Tax Deduction (TDS) will be deferred, and the employee will pay the tax in the year the deferral period ends, or the shares are sold.