The Employee Stock Ownership Plan (ESOP) is a crucial aspect of employee compensation and ownership in India, especially within the ambit of the country’s startup ecosystem. ESOPs have become an important tool for startups to attract, retain, and incentivize talented employees. Understanding the taxation rules surrounding ESOPs is essential for both companies offering ESOPs and employees who receive them.
In India, ESOPs are governed by specific taxation rules as set by the Income Tax Act, 1961. ESOPs are taxed differently at various stages – at the time of allotment of shares, exercise of options, and sale of shares acquired through ESOPs.
1. Allotment of Shares:
When an employee is allotted shares through an ESOP, the difference between the fair market value (FMV) of the shares on the date of allotment and the exercise price paid by the employee is considered as a perquisite and is added to the employee’s income. This perquisite value is subject to taxation under the head ‘Income from Salaries’ at the applicable income tax slab rates.
2. Exercise of Options:
When an employee exercises the option to purchase the shares allotted under the ESOP scheme, the difference between the FMV of the shares on the date of exercise and the exercise price is again considered as a perquisite and is added to the employee’s income. This perquisite value is subject to taxation under the head ‘Income from Salaries’.
3. Sale of Shares:
When an employee sells the shares acquired through ESOPs, the resultant capital gains are taxable. The capital gains would be classified as short-term capital gains (STCG) or long-term capital gains (LTCG) depending on the holding period of the shares. STCG is taxed at a higher rate as per the income tax slab rates, while LTCG on listed shares held for more than 12 months is taxed at a lower rate of 10% without indexation benefit.
Indian startup laws also provide certain exemptions and reliefs pertaining to ESOP taxation. The Finance Act, 2020 introduced a new section 80(i)(ac) which allows a deduction of up to 100% of the total income of an eligible startup for a period of three consecutive assessment years out of seven years from the year of incorporation.
Moreover, startups recognized under the ‘Startup India’ initiative may also avail benefits under Section 54GB of the Income Tax Act which provides relief from capital gains tax on the transfer of capital assets if the consideration is invested in the shares of an eligible startup.
It is important for employees to plan their tax liabilities carefully with respect to ESOPs and seek advice from professionals to optimize their tax outflow. On the other hand, companies need to ensure compliance with Indian laws while structuring their ESOP schemes to provide attractive and tax-efficient benefits to their employees.
In conclusion, the taxation rules governing ESOPs are an integral part of the Indian startup ecosystem and impact both employers and employees. Understanding these rules is essential for stakeholders to leverage ESOPs effectively as a tool for employee compensation and wealth creation. Awareness of Indian startup laws and policies can help in navigating the complexities of ESOP taxation and optimizing the benefits derived from such schemes.
