ESOP- EMPLOYEE STOCK OPTION PLAN
An ESOP is a type of employee benefit plan that allows employees to buy company stocks at a price below the market value, with the added benefit of ownership interest. Over time, employees can become equity shareholders in the company and benefit from its growth.
ESOPs are typically granted to employees as an incentive at the end of the financial year. They can motivate and appreciate employees by giving ownership of the company, which can help reduce employee turnover rates.
TAXABILITY OF ESOP’S
| Grant of ESOPs | Sale of ESOP Shares | Tax Deduction for employers |
| · When the ESOP is granted to the employee, it is not taxable as income.
· However, when the employee exercises the ESOP and acquires the shares, the difference between the fair market value of the shares on the date of exercise and the exercise price paid by the employee is taxable as perquisite in the hands of the employee. |
· When the employee sells the ESOP shares, the difference between the sale price and the fair market value of the shares on the exercise date is treated as capital gains.
· If the shares are held for less than 12 months, the short-term capital gains are taxed at the applicable rate. · If the shares are held for more than 12 months, the capital gains are long-term and are taxed at a lower rate. |
· Employers can claim a tax deduction for the cost of the shares issued to employees under the ESOP scheme.
· The deduction is allowed in the year the employee exercises the option and acquires the shares. |
SPECIAL BENEFIT FOR START-UPS
The eligible startups referred to in section 80-IAC and its employees would get the benefit of deferment of TDS and tax payment on perquisite arising from the happening of any of the following events (whichever is earlier)
- On the expiry of 48 months from the end of the assessment year in which securities are allotted under ESOP;
- From the date the assessment ceases to be an employee of the organization; or
- From the date of sale of securities allotted under ESOP.
Thus, an employee is required to disclose the value of perquisite from ESOPs in his return of his income for the year in which securities are allotted. However, due to the deferment of payment of tax, the employee shall not be required to pay tax on perquisites arising from ESOPs in such year.
The Tax to be payable on the salary income, excluding the perquisite value of ESOPs, should be computed as per the following formula: –
Tax payable on salary = Tax on total income X Total Income excluding ESOPs perquisites
income including including ESOPs Total Income including ESOPs perquisites
ESOPs perquisite perquisites
For Further clarification, please refer to the practical example provided below: –
NORMAL CASE
- First level of taxation (when the option is exercised):
Example 1: –On July 1, 2017, Mr. X exercised his option to purchase 10,000 shares of ABC Ltd. at an exercise price of INR. 60 per share. The fair market value (FMV) of the shares on the exercise date was INR 100 per share. Therefore, the perquisite value would be calculated as follows:
Perquisite value = (FMV per share – Exercise price per share) x number of shares allotted
= (100 – 60) x 10,000
= INR 400,000
So, INR 400,000 would be added to Mr. X’s taxable income as perquisite in the financial year 2017-18.
- The second level of taxation (when the shares are sold):
Example 2: -On January 31, 2018, Mr. X sold the shares at INR 120 per share. Therefore, the capital gain on the sale of shares would be calculated as follows:
Capital gain = Sale price per share – FMV per share on the date of exercise
= 120 – 100
= INR 20 per share
Since the shares were held for more than 12 months, the capital gain would be treated as a long-term capital gain. If the total capital gains on the sale of shares in the financial year 2017-18 exceed INR 1 lakh, Mr. X would have to pay long-term capital gains tax at the rate of 10% on the amount exceeding INR 1 lakh.
- START UP COMPANY CASE: –
Example: – Mr.A is working in an eligible start up company, has been allotted 100,000 shares at the rate of Rs.10 per share under the ESOP Scheme in the FY 2022-23. The fair market value of shares at the time of exercising of option by Mr.A is Rs.100. The perquisite value of ESOPs taxable in the hands of Mr.A shall be 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 the expiry of 48 months from the end of the AY in which shares are allotted and he does not sell the shares even after the expiry of said period. What will be the mechanism for deferment of TDS and tax on the perquisite value of ESOPs in such case?
- Assessment Year 2023-24
Mr.A would be required to disclose the perquisite value of ESOPs, i.e, Rs.90 lakhs in his ITR but he still not be liable to pay any tax thereon in the year of allotment of shares. The tax to be payable on the salary income, excluding the perquisite value of ESOPs, shall be computed in the following manner:
| Particulars | Amount |
| Total Income before including perquisite value of ESOPs (A) | 40,00,000 |
| Add: Perquisite Value of ESOPs (B) | 90,00,000 |
| Total Income after including perquisite value of ESOPs (C) | 1,30,00,000 |
| Tax on Rs. 1.30 crores as per slab rates applicable for Assessment Year 2023-24 as per old taxation regime (D) | 37,12,500 |
| Add: Surcharge [E = D * 15%] | 5,56,875 |
| Add: Education Cess [F = (D+ E) * 4%] | 1,70,775 |
| Total tax liability for Assessment Year 2023-24 after considering perquisite value of ESOPs [G = D + E + F] | 44,40,150 |
| Tax liability attributable to salary income (excluding the perquisite of ESOPs) [G* A/C] | 13,66,200 |
- B) Assessment Year 2027-28
As Mr. A continues with the company after the expiry of 48 months from the end of the AY in which shares are allotted and he does not sell the shares even after the expiry of said period, the liability to deduct tax or make payment of tax on perquisite value of ESOP will arise in the AY 2027-28, i.e., 48 months from the end of AY 2023-24 in which shares are allotted. The tax liability for AY 2027-28:
| Particulars | Amount |
| Total tax liability for Assessment Year 2023-24 after considering the perquisite value of ESOPS | 44,40,150 |
| Less: Tax already paid at the time of filing of return for the AY 2023-24 excluding the tax liability attributable to ESOPS | 13,66,200 |
| Differential amount to be deducted or paid by the employer or employee in the AY 2027-28 towards the tax liability attributable to ESOPS | 30,73,950 |
