Taxation of employee stock option plans

Employee stock option plans (ESOPs) have gained popularity among start-ups. Under ESOP, a company grants certain employees the right to purchase its stock at a pre-determined price (exercise price). This plan is spread over a period of time (vesting period). However, ESOP brings along with it the issue of taxes.

Here’s an example: Say, on 1 April 2021, Minali joined Company XYZ and had the option to purchase 500 shares at an exercise price of ₹510 per share. The vesting period is 20% at the end of each year of service in the company. On the said date, the market value of the company’s shares is ₹1,000 per share and Minali decides to buy 100 shares and pays an amount of ₹51,000 [510x100 shares]. The difference between the exercise price and the market value ( ₹490 per share x 100 shares) aggregating to ₹49,000 will be treated as a perquisite in Minali’s hands. The employer will deduct TDS on the same.  Every year, as the option vests and Minali exercises the option to purchase these shares, similar taxation would apply. Suppose Minali sells 100 shares on 1 May 2024 for ₹1,500 per share, long term capital gains (LTCG) of ₹50,000 [( ₹1,500 – ₹1,000) x 100 shares] will be applicable. 

The Finance Bill 2020 introduced some relaxation on taxation of perquisite on ESOPs issued by start-ups. These relaxations are available if the start-up: 

1. Was incorporated between 1 April 2016 and 31 March 2023 [as amended by finance bill 2022]

2. Has total turnover of less than ₹100 crores for the year in which benefit is sought.

3. Is certified as an eligible start-up by the inter-ministerial Board of the Government of India.

Let’s assume that company ABC is an eligible start-up fulfilling all conditions stated above. Manav joined the company on 1 April 2021 and had the option to purchase 5,000 shares at an exercise price of ₹1 per share. The vesting period is 20% at the end of each year of service. Suppose the fair market value of the company’s shares is ₹100 per share. Manav exercises the option to purchase these shares and pays an amount of ₹1,000 [ ₹1 x1000 shares]. The difference between the exercise price and the fair market value, that is, ₹99 per share x 1,000 shares aggregating to ₹99,000 will be treated as a perquisite in the hands of Manav. However, the tax on such perquisite will not be immediately payable and hence the employer will not have to deduct TDS on the same. 

The tax on this perquisite will be payable within 14 days from the occurrence of any of the following events:

a) Expiry of 48 months from the end of the relevant assessment year (AY); or

b) From the date of sale of such ESOP shares by the assessee; or

c) From the date of the taxpayer ceasing to be the employee of the ESOP allotting employer

The rates of tax in such cases shall be the one applicable for the year in which ESOP was allotted.

Scenario (a): Manav continues as an employee of company ABC and holds the shares. The shares were purchased in FY 2022-23 (AY 2023-24) and hence tax will be due at the expiry of 48 months from AY 2023-24 i.e. 31 March 2028. The tax will be payable by him within 14 days i.e. 14 April 2028. 

Scenario (b): Manav continues as an employee of company ABC but sells the shares on 30 June 2023. Tax on perquisite will be payable by him within 14 days. There is no change in the taxation of LTCG on sale of shares obtained under ESOP.

Scenario (c) : Manav ceases to be an employee of company ABC on 31 May 2023. Then the tax will be payable by Manav within 14 days.

In all three scenarios, the tax rate applicable on the perquisite amount of ₹99,000 will be the applicable tax rate for AY 2023-24.

ESOPs, as part of a remuneration package, also bring along with them tax liability. Employees need to consider the net benefit post the tax outgo if ESOPs are included in their salary package.

Nitesh Buddhadev is founder of Nimit Consultancy.