How ESOPs Are Taxed: All You Want To Know In 3 Brief Points!

Companies understand that quality human resource is of paramount importance when it comes to fulfilling their ambitions. An apparent factor which is of utmost eminence for any company is retaining employees, who are crucial to the well-being of the company, but at the same time, they are hard-pressed to hire more talents, in order to propel growth.

To attain this, companies take cognizance of the innovative means and ways by which they can incentivize employees. Salaries are spiced up by lucrative perks in order to retain and furthermore, motivate the workforce.

In modern times, there are innumerable strategies and schemes promoted by companies to enhance the economic package of deserving employees. Benefits like bonuses, life insurance, health insurance, pension, gratuity, ESOPs, paid vacations, free meals, etc. are a few add-ons that lure talent or help retain them.

1. ESOP: A Marvelous Way To Incentivize Employees!

ESOP is an abbreviation of Employee Stock Ownership Plan and it is granted to employees who get the shares of the company that they are employed in, at a discounted rate or even free!

ESOPs ensure loyalty, bring about long-term commitment, trigger a perception of ownership, a sense of belonging and above all, a strong motivation to work at optimum for the growth and advancement of the company.

2. Are Benefits Derived From ESOPs Taxable?

Yes, ESOPs are covered by the Income Tax Act, 1961, and means of taxation is enumerated in Sections 17 (2) (vi) and 49 (2AA).

The purchase, as well as the sale of ESOPs, are taxable, therefore, it can be stated that an employee has to pay tax at two stages.

3. How Are ESOPs Taxed?

Stage 1.

ESOPs attract tax in the first stance when the employee exercises his option, that is, buys the stock. The Exercise Price naturally is much below their Fair Market Value (FMV) and thus, the difference between the two is treated as a prerequisite in the hands of the employee, and the employer is bound to deduct tax at source.

The determination of FMV is done differently for listed and unlisted shares. In the case of a listed share, the FMV is calculated by averaging the opening and closing price on that particular date.

On the other hand, if the share is unlisted, then, the FMV is finalized by a registered Merchant Banker, on the specific date.

Stage 2.

ESOPs attract tax a second time when the allotted shares are sold off. The profit derived by the sale is treated as gains and is taxed as short-term or long-term capital gains, depending on the length of the period it is held.

Once again, there are two different mechanisms of taxation depending on whether the stock is listed or unlisted.

For a listed share, the law maintains that a holding period of more than 12 months will deem it to be long-term capital gains and shall be charged at 10% without indexation benefit. On the contrary, less than 12 months of holding will render it as short-term capital gains and will be taxable at 15%.

In the case of unlisted shares, the holding period doubles up, and therefore, holding the shares for more than 24 months will be considered long-term capital gains. In such cases, the tax shall be levied at 20% with indexation benefit and 10% without indexation benefit. If held for less than 24 months, it shall be treated as short-term capital gains and will be taxable as per the slab rate of the employee.

Final Word!

Though ESOPs are a popular tool of incentivizing, they attract lots of compliances by different regulators, leading to a lot of paperwork and more importantly, are taxed twice! To save themselves from such cumbersome procedures, the companies have started awarding Phantom stocks, which come with complete flexibility and fewer compliances.