UNDERSTANDING THE TAXABILITY OF ESOP GAINS

According to Section 2(37) of companies Act, 2013, Employees stock option schemes  is an option given to the directors, employees or officers of the company or its holding and subsidiary company, the right to purchase or benefits or subscribe for the shares of the company at the pre determined price for a future dates.  Therefore ESOPS are issued to motivate their current employees or directors  by giving them stake in the profits of the company

According to section 12(1) of companies (Share Capital and Debenture) Rules, 2014 ESOPS can be issued to

1. Permanent employees of parent or subsidiary company working in India or outside India
2. Directors of the company including whole time or part time director but not including independent director.

TAX DEDUCTIBLITY OF ESOPS

ESOPS are taxable at two instances

• At the time of exercise
• At the time of sale
• At the time of exercise: The amount of perquisites shall be determined on the difference between the fair market value of shares (FMV) with that of the exercised price of the shares. This perquisite forms the part of total income from salary and should be filed in employee’s Form 16
• At the time of sale: The amount of perquisite shall be determined on the difference between the face value of shares with that of consideration received on sales of these shares. This perquisites forms the part of capital gain (whether LTCG or STCG depending upon the period of holding of these shares)

How to calculate FMV Of shares?

In case of Listed shares: If the shares a listed or traded on recognised stock exchange the face value of each shares will be the average of opening plus closing price on that of listed in the stock exchange. However if the shares are not traded on the stock exchange the closing price of the preceding date of exercise will be considered as FMV.

In case of Unlisted shares: The FMV should be the value of shares that is determined by a merchant banker.

DETERMINING THE NATURE OF THE GAIN

In case of listed company: According to section 111A of Income tax Act, if the shares are held for a period that is less than or equal to 12 months, the gain arising out of sale of shares is considered to be short term capital gain. If the shares is held for more than 12 months it is considered to be long term capital gains. According to section 112A if the capital gain is more than 1 lakhs a rate of 10% without indexation is applicable.

In case of Unlisted Company: If the shares are held for a period that is less than or equal to 24 months, the gain arising out of sale of shares is considered to be short term capital gain. If the shares is held for more than 12 months it is considered to be long term capital gains. According to section 112A the capital gain is chargeable at the rate of 20% with indexation benifits.

Taxability on behalf of the employer

In the case of CIT vs. Lemon Tree Hotels Limited, ITA 209/DEL/2014 it was held by the high court of Delhi, the expense related to ESOPS was to be allowed as an expense and thus the company can claim deduction for it.

Taxability of ESOPs from an eligible startup

According to Finance amendment act,2020 in case employees recievees ESOPS  from an eligible startup, tax on the perquisite shall be deductible on earlier of the two events

• After the expiry of 5 years from allotment
• On the date of sale
• On the date of exit from the company.