Employee Stock Option Plan or in short ESOP is another benefit plan to employees making them a part owner of the company. This is one of the best motivating tools used by management of the company in which it tries to retain, reward, compensate and attract its employees. Today many business entities (whether existing market player or a Startup) both at India and abroad, are utilising this scheme as an essential tool to reward and motivate their employees. This is a scheme where employees are provided stake in the company in the form of shares/options at reduced price than what prevails in the market. These benefits so offered is a right granted to the employees to apply for the ESOPs or Sweat Equity shares at a predetermined price, but there is no obligation on them to accept the offer. So let us get into details of all about ESOP, its taxation & tax planning for the same.
ESOPs are stock options granted to employees over a vesting period (vesting period refers to the minimum period for which a stock option must be held before it can be exercised), where the employee is given the right to purchase the company’s shares at a predetermined price or the exercise price. If the employee does not exercise the option within a time prescribed by the company, the option automatically expires. For tax purposes, ESOP benefits received by the employee will be taxable as perquisite. It will be the difference between the fair market value (FMV) of the shares on the date of exercise of the options less the exercise price. However it shall be taxable only when shares are allotted under ESOPs. The employer is also required to deduct TDS in respect of such perquisite.
Tax Treatment of ESOPs Allotment
Treated as Perquisite: Allotment of ESOPs are taxed as perquisite which is the difference between the Fair Market Value (FMV) of the shares on the date of exercise of the option and the price recovered from the employee. Such FMV of the securities has to be calculated on the date on which the option is exercised by the employee. Vide circular no.710 dated July 24, 1995, the Central board of Direct Taxes (CBDT) clarified that shares issued to employees at less than market price amounted to a perquisite under section 17(2)(ii). However, to remove any uncertainty with regard to taxability of such benefits, a new sub-clause (iiia) was added to section 17(2) by the Finance Act, 1999 to provide that when any share, security etc. was offered directly or indirectly by the employer, the difference between market value of the stock and the cost at which it was offered was to be taxed as perquisite in the year in which the right was exercised.
Tax Liabilities on Employee while selling of ESOPs
When the employee sells the shares subsequently, the gains will be taxed as capital gains. The capital gains will have to be computed as the difference between the sale proceeds and FMV of the shares that was considered by the employer while computing the perquisite value including any expenditure incurred wholly in connection with the sale. The capital gains tax implications would depend upon the period of holding of shares from the allotment date and whether security transaction tax (STT) has been paid.
At the time of sale, any gain beyond tax value of the shares may be subject to capital gains tax, depending on whether the shares are listed in India and the period of share holding with regards to determine Short Term Capital Gains (STCG) or Long Term Capital gains (LTCG). For listed shares where the STT is paid, there would be no tax if shares are held for more than one year, but the same is taxed at 15.45% if held for less than one year. In case of unlisted shares, the tax rate is 20.60% with indexation if held for more than
one year three years (with effective from July 10, 2014 as per Finance Bill 2014) and in case of holding period is less than a year three years, it is taxable at normal rates of taxes (based on the income slab).
Short Term Capital Gains (STCG) from listed shares which are subject to STT can be adjusted with any Capital Loss (except long term losses from equity shares and units of equity oriented mutual funds), losses from House Property, losses from Business or Profession (other than speculation or depreciation) in the same financial year in which such STCG arise.
There is nothing can be done for the unlisted shares which are sold and you incur STCG. These gains will get added to your income and taxed at normal rate based on your income slab. But with regards to unlisted Long Term Capital Gains (LTCG on listed shares are tax free if sold at recognised stock exchange), you can save 20.60% of tax liability with the benefits available under section 54EC and section 54F.
The section 54EC of the Income-tax Act, 1961 allows a deduction in respect of LTCG arising from sell/transfer of any long term capital asset (for example, any immovable property, jewellery or shares) which was held for a period exceeding three years. In case of shares, the holding period should be 1 year. Investments done in bonds under section 54EC (such as REC/NHAI Bonds) within six months from the date of sale provide exemption of LTCG to the extent of investment.
Section 54F is available to all those assets other than residential houses properties (available to person who is an individual or HUF). So for claiming long term capital gains arising to shareholders, this section can be utilized. As per this section under the Income Tax Act, 1961; tax on LTCG from the transfer/sale of these shares will not be chargeable if the entire net sales considerations is utilized purchase of a new residential house within a period of one year before, or two years after the date of transfer/sale. The sale consideration can also be utilised to save taxes within a period of 3 years in construction of residential house.