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Understanding the Taxability of ESOP Gains

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

According to the companies (Share Capital and Debenture) Rules, 2014- section 12(1), Employees stock option schemes can be issued to

  1. Parent or subsidiary company’s permanent employees who are working in India or outside India
  2. Company’s Directors including full time or part time director but not including independent director.

Tax Deductiblity of Employees stock option schemes:-

ESOPS are taxable at two instances

  • At the time of exercise
  • At the time of sale

(i) At the time of exercise: The amount of perquisites will be determined on the difference between the fair market value of shares (FMV) with that of the share’s exercised price. This perquisite forms the part of total income from salary and should be filed in the form 16 of the employee.

(ii) At the time of sale: The amount of capital gain will be determined on the difference between the fair market value of shares (i.e. the share’s cost price when the same were allotted (Perquisites plus Paid amount by the assesse) with that of consideration received on sale of these shares. This forms the part of capital gain (whether Long-term capital asset or Short-term capital asset depends upon the period of holding of these shares)

How to calculate FMV Of shares?

In case of Listed shares: If the shares are listed 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 listed or traded on the stock exchange the closing price of the preceding date of exercise will be considered as fair market value of shares (FMV).

In case of unlisted shares: The fair market value of shares (FMV) should be the value of shares which is determined by a merchant banker.

Determining the Nature Of The Gain

In case of listed company: As per the Income tax Act- section 111A , if the shares are held for a period that is less than or equal to twelve months, the gain arising out of sale of shares is considered to be STCG i.e. short term capital gain. If the shares are held for more than twelve months it is considered to be long term capital gains. According to section 112A if the capital gain is more than INR 1 lac 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 twenty four months, the gain arising out of sale of shares is counted to be STCH i.e. short term capital gain. If the shares are held for more than 24 months it is considered to be LTCG i.e. long term capital gains. As per the section 112A the capital gain is chargeable at the rate of 20 percent with indexation benefits.

What is the Taxability On Behalf Of the Employer?

In the case of CIT V/S Lemon Tree Hotels Limited, ITA 209/DEL/2014 it was held by the Delhi high court, the expense related to Employees stock option schemes was to be allowed as an expense and therefore the company can claim deduction for it.

What is the Taxability of ESOPs from an eligible startup?

As per the Finance amendment act, 2020 in case employees receives Employees stock option schemes  from an eligible startup, tax on the perquisite will be deductible on earlier of the following events:-

  1. After the expiry of five years from allotment
  2. On the date of sale
  3. On the exit date from the company.