Employee Stock Ownership Plans (ESOPs) are a popular incentive tool used by companies to attract and retain employees by offering them an ownership stake in the company. However, understanding the tax implications of ESOPs is crucial for both employees and employers. This blog post will provide a comprehensive overview of ESOP taxation, focusing on listed, unlisted, and foreign companies.
Prerequisite Taxation
When ESOPs are allotted to an employee, they are taxed as a perquisite. The perquisite value is calculated as follows:
Perquisite Value = Fair Market Value (FMV) on the date of exercise – Pre-determined price of the option.
This amount is included in the employee’s income and taxed accordingly.
TDS (Tax Deducted at Source) for Eligible Startups
For employees of eligible startups, the TDS on ESOPs is deferred to the earlier of the following events:
- Five years from the date of allotment.
- Date of sale of shares.
- Termination of employment.
It’s important to note that employees of eligible startups cannot file ITR-1 if they have deferred TDS.
Sale of Shares by Employee
When an employee sells the shares acquired through ESOPs, the tax implications are determined by calculating the capital gains. The calculation is as follows:
Capital Gains = Sale Value – Cost of Acquisition (COA) – FMV on Exercise Date.
Additionally, if the shares of a foreign company are sold, the employee must fill the FA (Foreign Assets) schedule, irrespective of the holding period.
Taxation Based on Holding Period and Type of Company
The taxation rules for capital gains arising from the sale of ESOP shares depend on the type of company (listed, unlisted, or foreign) and the holding period of the shares.
Listed Company
- Holding Period > 1 Year: Long Term Capital Gains (LTCG) are taxed at 10%, with an exemption for up to ₹1 lakh of LTCG.
- Holding Period < 1 Year: Short Term Capital Gains (STCG) are taxed at 15%.
Unlisted Company/Foreign Company
- Holding Period > 2 Years: LTCG is taxed at 20% with the benefit of indexation.
- Holding Period < 2 Years: STCG are taxed as per the individual’s applicable income tax slab rates.
Key Points to Remember
- Perquisite Taxation: ESOPs are taxed as a perquisite at the time of exercise.
- Deferred TDS for Startups: For eligible startups, TDS on ESOPs can be deferred to specific future events.
- Capital Gains Calculation: Upon selling the shares, capital gains need to be calculated based on the sale value, COA, and FMV on the exercise date.
- Foreign Assets Schedule: The FA schedule must be filled when shares of a foreign company are sold.
- Varying Tax Rates: The tax rates for capital gains differ based on the holding period and whether the company is listed or unlisted.
Understanding these aspects of ESOP taxation can help employees make informed decisions and comply with tax regulations effectively.