Got an ESOP? Know how income tax is calculated and how to save tax

With such compensation comes tax. Kuldeep Kumar, Partner – Price Waterhouse (PwC) explained that taxation happens at the time of exercise when shares are allotted and then later when shares are sold.

ESOP is taxed on the amount which is calculated as the difference between the exercise price and the market price on the date of such exercise of the ESOP. Such difference is treated as perquisite in the hands of the employee and taxed under head salary.

“ESOP is held as perquisite, which is included in the computation of salary and is taxable accordingly. The tax rate is as per the slab rate applicable to such persons and tax is payable accordingly. Any particular tax rates which are otherwise applicable to ESOPs,” said Saurav Sood, Practice Leader (International Tax), SW India.

The issue of tax arises when the employee exercises his entitlement to ESOP and such differential value is added to the salary of the employee and the employer is bound to calculate the withholding tax on the salary amount. including condition for ESOP) and deduct accordingly.

There is no further effect in the hands of the employee as the employer withholds tax on the entire amount of such perquisite. “Further, where the employee subsequently sells such shares in the market, the capital gains shall be applicable on the sale of shares and shall be the personal tax liability of the employee and the taxes shall be paid by the employee,” Sood said.

In the first phase, ESOP income as employment income is taxed at the normal slab rate plus applicable surcharges and education and health cess. Whereas, in the second stage the income is taxed as capital gain.

tax saving opportunities

“Taxes can be deferred when it comes to ESOPs by slightly lengthening the exercise period and making it parallel to the event of selling in the open market. By doing so the outflow of tax by way of deduction of withholding tax can be reduced through funds from the sale of shares in the market. Capital gains on such sale of shares have no immediate tax effect and need to be included in computation of tax at the time of filing annual income tax return,” said Saurav Sood, Practice Leader (International Taxes), SW India said .

“In order to save tax on LTCG, employees can avail capital gains tax savings by reinvesting the capital gains in specified securities under section 54EE (maximum limit of Rs 50 lakh) of the Act or by investing the sale proceeds in a residential house. Section 54F of the Act, subject to fulfillment of the specified conditions contained in Section 54EE and 54F respectively,” said Kumar of PwC.

In case of employees of eligible start-ups, exemption is provided by deferring the payment of tax arising on the date of exercise/allotment.

For these employees tax is deducted/paid on employment income earned by exercise of option within 14 days at the earliest of the following events – End of 5 financial years from the end of the relevant financial year in which the share under ESOP is allotted, or the date of the employee leaving the employment, or the date of sale of such shares.