Employee Stock Option Plan (ESOP) & its Tax Implication

Employee Stock Ownership Plan (ESOP) is a system wherein the employees of the company are given the right to acquire the shares of the company for free or at a concessional rate which remains in the ESOP Trust Fund until the option vests and the employees exercises them or the employees leaves/retires from the company. These plans are aimed at improving the performance of the company and increasing the value of the shares by involving stockholders, who are also the employees of the company. The terms and conditions on which employee can exercise his rights are implied in the ESOP scheme. The option given to the employee can be exercised after a certain lock in period, which is generally more than one year. There is no obligation which mandates the employee to exercise the option. However, the employee must exercise the option within a stipulated period falling which the vested right may lapse.

Tax implication of ESOP in India

ESOP is taxed in two stages. First is when the employee exercises the option to buy the shares at the exercise price and later when the shares are sold.

1. Tax implication when exercising the option The difference between the exercise price and the value of the security is treated as perquisite in the hand of the employee. The employer is required to deduct tax at source on the employee exercising the option, treating the same as perquisite. The value of the shares allotted to the employee shall be the average of market price (average of highest and lowest price) on the date the option is exercised in case the shares are listed on any stock exchange in India. In case the shares are not listed the fair market value of the same shall be as per the valuation certificate obtained from merchant banker.

Budget 2020 amendment: From the FY 2020-21, an employee receiving ESOPs from an eligible start-up need not pay tax in the year of exercising the option. The TDS on the ‘perquisite’ stands deferred to earlier of the following events:

a. Expiry of five years from the year of allotment of ESOPs

b. Date of sale of the ESOPs by the employee

c. Date of termination of employment

2. Tax implication when shares are sold The incidence of sale will attract capital gains tax. The gains can be either long term or short term, depending on the period for which the employee has held the shares.