This particular post is an extract from the Q&A section of recent conversation on a social media regarding ESOP (Employee Stock Option Plan). Though I answered to all the queries, but I still feel there are many who have similar questions and they should refer this to clear the ambiguities they have. In fact any further questions can be asked by the reader via comment section, I would love to answer them. Here it goes;

Does anyone have a good resource handy for information regarding ESOP taxation? Specific queries are:

  1. When option is exercised, difference in option price and market price is clubbed as per-requisite and there needs to be TDS on this. Question: When there is no tangible gain (after all, higher market price is notional gain till that stock is sold), how does income tax play a role here?
  2. Once stock is sold by the employee, capital gains is applicable. Does vesting period also get considered when calculate holding period for LTCG or STCG or does the clock start from the actual date of purchase / exercise of option, or some thing?
  3. Say I hold options that have not yet been exercised but have vested, and the company is going to get acquired. How does it work in this case? Do I exercise the options (and pay income tax on notional gain) and then sell them to the acquirer (and now pay STGC), or some other way?

Much thanks!

ESOP Queries

Refer below for complete answers with explanations;

Answer 1: The difference between FMV (Fair Market Value) and Exercise price (or the price recovered from employee) is treated as perquisite and is added as taxable income. Normally employer (through banker) adjust the TDS and credits you the net amount. You see these in your form 12BA.

Explanation: In addition to this, Option Price does not play any role in calculation of Perquisite value. Yes! Taxation is involved because the value you are going to get as ESOP, you are not paying anything to acquire those options. Here what you are paying is, only tax while exercising these options. As you receive sum not in cash, but in kind therefore you are liable to pay income tax on the same.

Answer 2: No! Vesting period is not considered. It is to do with the date of exercise till the date of sale for the purpose of calculation of duration for capital gains. Either STCG or LTCG!

Explanation: Until you buy the shares, you do not have rights to sell them. Employer grant options and there is a period which is called as vesting period at which you need to acquire them. Once you acquire/exercise options you became owner of asset, from here period will be calculate for STCG or LTCG.

Answer 3: It is your choice to exercise if it’s vested. Sometimes when company gets acquired there is a force exercise happens where it treated as purchase done by you and at the same time sale also happens. In that case simultaneously two transaction happen, 1) Exercise and 2) Sale. You have to pay tax on Perks and Capital Gains tax on STCG or Business income (if sold in same day).

Explanation: Re-read the word “OPTION”, it is called as option which means, you got an option whether to opt or leave. Generally there is always a period given by employer where option gets expired. It means, if you don’t exercise the option, you will be losing the rights to acquire the said asset which is been offered to you with no consideration.

P.S. Actually there is a real Gain (nothing Notional), but due to such technicalities of transactions most of employees think that they don’t get anything, but pay tax 🙂

Some common queries on ESOP being answered!

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