Employee stock option plans (ESOPs) have gained popularity amongst start-ups. Under ESOP, a company grants certain employees the right to purchase its stock at a pre-determined price (exercise price). This plan is spread over a period of time (vesting period). However, ESOP brings along with it the issue of taxes.
Here’s an example: Say, on 1 April 2021, Minali joined Company XYZ and had the option to purchase 500 shares at exercise price of Rs. 510 per share. The vesting period is 20% at the end of each year of service in the company. On the said date, the market value of the company’s shares is Rs.1,000 per share and Minali decides to buy 100 shares and pays an amount of Rs. 51,000 [510x100shares]. The difference between the exercise price and the market value (Rs. 490 per share x 100 shares) aggregating to Rs. 49,000 will be treated as perquisite in Minali’s hands. The employer will deduct TDS on the same. Every year as the option vests and Minali exercises the option to purchase these shares, similar taxation would apply. Suppose, Minali sells 100 shares of Company XYZ on 1 May 2024 for Rs. 1,500 per share, long term capital gains (LTCG) of Rs. 50,000 [(Rs. 1,500 – Rs. 1,000) x 100 shares] will be applicable.
Finance Bill 2020 introduced some relaxation on taxation of perquisite on the ESOPs issued by start-ups. These relaxations are available if the start-up:
- Was incorporated between 01/04/2016 and 31/03/2023 [as amended by finance bill 2022]
- Has total turnover is less than ₹100 crores for the year in which benefit is sought
- Is certified as eligible start-up by the Inter-Ministerial Board of the Government of India.
Let’s assume that company ABC is an eligible start-up fulfilling all conditions stated above. Manav joined the company on 1 April 2021 and had the option to purchase 5,000 shares at exercise price of Re. 1 per share. The vesting period is 20% at the end of each year of service. Suppose, the fair market value of the company’s shares is Rs. 100 per share. Manav exercises the option to purchase these shares and pays an amount of Rs. 1,000 [Re. 1 x1000 shares]. The difference between exercise price and fair market value i.e. Rs. 99 per share x 1,000 shares aggregating to Rs. 99,000 will be treated as perquisite in the hands of Manav. However, the tax on such perquisite will not be immediately payable and hence the employer will not have to deduct TDS on the same.
The tax on this perquisite will be payable within 14 days from the occurrence of any of the following events :
- Expiry of 48 months from the end of the relevant assessment year (AY); or
- From the date of the sale of such ESOPs shares by the assessee; or
- From the date of the taxpayer ceasing to be the employee of the ESOP allotting employer
The rates of tax in such cases shall be the one applicable for the year in which ESOP was allotted.
Scenario (a) : Manav continues as an employee of company ABC and holds the shares. The shares were purchased in (FY 2022-23) AY 2023-24 and hence tax will be due at the expiry of 48 months from AY 2023-24 i.e. 31 March 2028. The tax will be payable by him within 14 days i.e. 14 April 2028.
Scenario (b) : Manav continues as an employee of company ABC but sells the shares on 30 June 2023, tax on perquisite will be payable by him within 14 days. There is no change in the taxation of LTCG on sale of shares obtained under ESOP.
Scenario (c) : Manav ceases to be an employee of company ABC on 31 May 2023. Then the tax will be payable by Manav within 14 days.
In all three scenarios, the tax rate applicable on amount of perquisite of Rs. 99,000 will be the applicable tax rate for AY 2023-24.
ESOPs as a part of remuneration package also brings along with them tax liability. Employees need to consider the net benefit post tax outgo if ESOPs are included in their salary package.
Nitesh Buddhadev is founder at Nimit Consultancy