A right is granted by the company to certain employees to purchase a specified amount of stock in the company over a specified period at a pre-determined price (exercise price), under an ESOP plan, however, there is no obligation on the employees to purchase the same. Employees Stock Option Plan (ESOP) has become a common tool for many companies to attract and retain talent.
With such compensation, comes taxes as well. The taxation takes place at the time of exercise when shares are allotted and then later when the shares are sold, explained Kuldip Kumar, Partner – Price Waterhouse & Co LLP.
ESOPs are taxed on the amount which is calculated as a differential between the exercise price and market price on the date of such exercise of ESOPs. Such difference is treated as perquisite in the hands of the employee and taxed under the head salary.
“ESOPs are held as perquisite, which are included in the computation of salary and taxable accordingly. The rate of tax is as per the applicable slab rate to such individuals and tax is payable accordingly. There are no special tax rates that are applicable to ESOP otherwise,” said Saurrav Sood, Practice Leader (International tax), SW India.
The point of the tax is when the employee exercises its right for the ESOPs and such differential price is added to the salary of the employee and employer is duty-bound to compute withholding tax on the salary amount (including the prerequisite on account of exercising the ESOP) and deduct accordingly.
There are no further implications in the hands of the employee since the employer withholds taxes on the entire amount of such perquisite. “Further, where the employee sells such shares in the market subsequently, the capital gains shall apply on the sale of shares and it will be the employee’s personal tax liability and taxes shall be paid by the employee accordingly,” Sood added.
ESOP income taxed as employment income at the first stage is taxed at normal slab rate plus applicable surcharge and education and health cess. Whereas, income is taxed as capital gains at thsecond stage.
Tax saving opportunities
“The taxes can be deferred if not saved when it comes to ESOP by stretching the exercise period a bit longer and making it in parallel to the event of the sale in the open market. By doing this, the outflow of tax through deduction of withholding tax can be mitigated through money from the sale of shares in the market. The capital gains on such sale of shares do not have any immediate tax effect and need to be included in the computation of tax at the time of filing of annual income tax return,” said Saurrav Sood, Practice Leader (International tax), SW India.
“In order to save tax on LTCG, employees can explore saving capital gains tax by reinvesting the capital gains into specified securities u/s 54EE (Maximum limit Rs. 50 lakhs) of the Act or investing the sales consideration in a residential house u/s 54F of the Act, subject to meeting the specified conditions as contained in Section 54EE and 54F respectively,” said Kumar of Price Waterhouse & Co LLP.
In case of employees of eligible start-ups, there is a relaxation provided by deferring the payment of tax arising on the date of exercise/allotment.
The tax is deducted/paid for these employees on the employment income earned from exercise of option within 14 days from the earliest of the following events – Expiry of 5 financial years from the end of the relevant financial year in which the shares under ESOP have been allotted, or date of the employee leaving the employment, or date of sale of such shares.
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