Shares under employee stock ownership plan are taxed at the time of allotment and sale

When you sell these shares, gains from the sale will be taxed as capital gains


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What is the tax implication while exercising the employee stock ownership plan (ESOP). What is the difference between the fair market value (FMV) and grant price? After exercising ESOPs, should their FMV, and the perquisite tax paid be, considered under the head ‘salaries’ when filing tax?

— Gopinath N.

As per the Income-tax Act, 1961, there are two stages of taxation for shares allotted to employees under an ESOP.

The first trigger point of taxation is when the shares are allotted to the employee by her company upon exercise of the vested options under ESOP. The same is taxed as salary or perquisite in the hands of the employee. The second is when the employee sells these shares.

In the first stage, the difference between the FMV of the shares on the exercise date and the exercise or subscription price paid by the employee, if any, is taxable as perquisite under the head ‘income from salary’ on the date of allotment of shares. The employer will have to compute and deduct the tax on perquisite or salary resulting from allotment of shares to you under ESOP.

The tax rate would depend upon your applicable income slab in the financial year (FY) in which shares are alloted. Further, surcharge (as applicable) and education cess shall be applicable in addition to the income tax. The income and the perquisite tax deducted by the company thereon would be reflected in your Form 16/12BA. You have to report this as part of salary in your income tax return (ITR).

For the purpose of calculating the perquisite value, FMV of the share on the date of exercise of the option has to be determined as per the method specified in Rule 3 of the Income-Tax Rules, 1962. For shares listed on a recognised stock exchange in India, the FMV shall be average of the opening and closing price on the date of exercise of options subject to the conditions specified in the aforesaid Rule. In case of unlisted shares or foreign shares, the FMV has to be determined by a Category I merchant banker registered with the Securities and Exchange Board of India.

When you sell these shares, gains from the sale will be taxed as capital gains. The capital gains will have to be computed as the difference between the sale proceeds and FMV of the shares that was considered by the employer while computing the perquisite value, including any expenditure that may have been incurred wholly in connection with the sale.

Capital gains tax implications would depend upon the period for which the shares were held from the allotment date, whether securities transaction tax has been paid, re-investment in house property or specified bonds within specified time frames subject to the prescribed conditions.

I have completed over 5 years in my company and plan to change. I want to withdraw my provident fund (PF) amount as I have some personal exigencies. What are the tax implications?

—Ruchi Balwani

Just for your information, the withdrawal of PF will be as per provisions of the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952, which requires you to have a non-employment period of 2 months after leaving your job.

The withdrawal of the accumulated balance from a recognised PF is taxable if the employee has not rendered continuous services for 5 years or more to the employer. While computing the continuous services of 5 years, the period of previous employment is also included, if the accumulated balance maintained with the old employer is transferred to the PF account of the new employer.

Assuming this is your first job, there is no transfer of accumulated PF balance from previous employer. As the total years of service is more than 5 years, there will not be any tax implication on withdrawal of the accumulated PF balance. But disclose the PF withdrawal in your ITR.

Parizad Sirwalla is partner (tax), KPMG.

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