Esops Are Great, But They Come With Taxes Too

It is important to know the tax rules applicable to Esops before accepting the offer. Because, it may need to pay taxes on notional gains even before the value from the offer is received in cash.

tax relief

ESOPs are taxed in two ways. One, as perquisite as part of salary at the time of allotment of shares and two- as capital gain on sale of shares.

startup industry Have been demanding relief from tax in the form of perquisite on ESOP for a long time. The issue here is that the employee does not receive any cash when the shares are allotted, but they are required to pay tax on it in that year.

In case of unlisted shares, this problem becomes more significant as there may be no way to sell the shares, pay taxes.

However, Budget 2020 deferred tax liability for some startups by 4 years. The tax payable on allotment of shares was deferred for 48 months from the end of the assessment year in which the shares were allotted.

Let’s say, you were given an ESOP in November 2021. The applicable assessment year (AY) in this case is 2022-2023. Instead of being taxed in AY23, Esops will now be taxed in AY27, but using the applicable slab rates for AY23.

This exemption is only applicable for eligible startups, including:

1) Incorporated between 1st April 2016 and 1st April 2022

2) Has a turnover of less than 100 crore

3) Possess a certificate of eligible occupation from Govt.

Budget 2022 amended the definition of eligible startups to include startups incorporated by March 31, 2023. “This would mean that ESOPs offered by startups incorporated by March 2023 will also be eligible for waiving off tax on perquisites,” Gidwani said.

While this is another positive news, the budget does not propose to demand relief to all startups. “It is ideal if the 4-year relaxation available to startups is extended to employees of unlisted companies as well,” said Arti Rawate, partner, Deloitte India.

profit tax

Value of shares received as perquisite will be added as part of salary and will be taxed at applicable tax rates.

The value of the perquisite will be the fair market value (FMV) of the shares on the day you exercise your option minus the amount paid to the company for ESOP. Let’s say you used 100 Esops in the company which are valuable 1 lakh in the market ( 1000 per share), which were offered to you at 50,000 ( 500 per share). difference of 50,000 will be treated as perquisite for taxation purpose.

If the stock is listed as of the date the option is exercised, the FMV is the average of the stock’s opening price and closing price on that day. In the case of an unlisted share, the FMV shall be that which is determined by a merchant banker on the specified date.

The perquisite becomes chargeable to tax in the year of allotment of shares. As mentioned above, for eligible startups, tax is levied after four years from the end of the assessment year in which the shares are allotted. But there are some conditions.

If the employee quits the job or sells the shares before the said 48 months, the value of perquisite in the hands of the employee in the year of exit or sale will be taxed.

For example, based on the above example, if you leave the organization in May 2022, the perquisite becomes taxable only in FY 23 (AY 23-24).

The company will also deduct TDS (tax deducted from source) in the year in which the value of perquisite in the hands of the employee becomes taxable. Thus, employees should be prepared for a lower take-home pay in the year that ESOPs are taxed.

capital gain on sale

Capital gains taxation in case of ESOP is not different from computing capital gains on sale of shares. Except that in this case the cost of acquisition of the shares is the FMV of the shares considered for computing the value of the perquisite.

In the above example where you were allotted 100 esops, the FMV of the cost of acquisition is 1 lakh no more 50,000 paid by you to the company, as the difference would have already been taxed as perquisite.

If the shares are listed and the shares are sold after 12 months, the long-term gains exceed 1 lakh will attract 10% tax. Otherwise, the gain will be taxed as short-term capital gain at the rate of 15%.

If the shares are unlisted, the holding period for computing capital gains is 24 months. Short-term gains are taxed at slab rates, while long-term gains are taxed at 20% with indexation benefit (revision of cost of acquisition after considering inflation).

However, this LTCG is also subject to surcharge for high earners. The Budget 2022 proposal to cap surcharge on sale of long-term capital assets, including unlisted equity shares, to 15% is a positive piece of news for those holding high value (above) ESOPs. 2 crore).

“Earlier the effective tax rate on LTCG could go up to 28.5 per cent with the highest surcharge of 37%, now the effective tax rate will be 23.9% with 15% surcharge,” said Sunil Gidwani, partner, Nangia Andersen. To save tax on the other hand, one can use section 54F, which provides exemption in respect of long-term capital gains if the money is invested in buying or building a house property.