Is ESOP Taxable?

1 August 2023

1,009 4 mins read

ESOPs provide great scope for small companies to retain their employees. Read on to know more about ESOP taxation in India!

The first thing we have to know is what is ESOP in order to know if ESOP is taxable or not! An ESOP, or Employee Stock Option Plan, is a scheme offered to employees which offers unique rewards to employees and allows them to acquire significant retirement advantages at no expense. This way, it encourages the employees of the company to take ownership of their tasks, as technically they also own a part of the company shares, thereby decreasing the rate of employee turnover. The company’s shares are offered to the employees of the company at the end of the year to ensure high employee engagement & satisfaction in the company.

Table of Contents

Who Has The Authority To Issue The ESOP?

According to Rule 12(1) of the Companies (Share Capital and Debentures) Rules of 2014, an Employee Stock Option Plan can be offered to the following employees:

A part-time or whole-time director of the company. However, it can not be issued to an independent director.
A permanent employee in the company, regardless of whether he works outside or in India.
A permanent director or employee of a holding company in or outside of India, a subsidiary company, or an associate company.

What Is The Advantage Of ESOP?

Since employee stock option plan shares are part of the employee’s compensation package, companies can apply ESOP scheme to retain employees focused on the company’s performance as well as share capital appreciation. These ESOP schemes encourage and help to motivate employees to do what is best for the shareholders of the company. Meanwhile, through ESOPS, employees are offered the scope to earn more money, grow their remuneration, and most importantly, be rewarded for their commitment and service to the company. The employees feel more recognised and appreciated if they are also having a stake in the company. It also helps to make work interesting for them.

What Are The Disadvantages Of Employee Stock Option Plans?

Although employees stock option plans have many benefits, it can be difficult for employees to understand the tax liability.
Dilution can cost shareholders a lot of money over time.
It might be difficult to value employee stock options.
For average business results, stock options might lead to high CEO compensation levels.
To be eligible for a bonus, an employee must depend on the combined efforts of their management team and coworkers.

Is ESOP Taxable?

Yes! ESOP is taxable. The concepts of sweat equity and ESOP are connected. According to the income tax act, the value of any employee stock option plan and sweat equity shares transferred or allotted, both indirectly or directly by the ex-employer or the present employer, free of any expenses or at a compromised rate, is taxable.

When an employer or business owner makes an allotment of sweat equity shares to its employees, the allotment is held as a necessary condition in the income tax assessment of the company’s employees. The Finance Minister introduced a new procedure for including the Employee Stock Option Plan in the Budget 2020. According to this declaration, tax payment on the Employee Stock Option Plan, or ESOP, is extended for 5 years or till the end of the employment of an employee or at the time of trading of the stocks, whichever takes place first.

When is ESOP tax calculated?

Tax on employee stock option schemes is calculated at 2 stages:

The first levy is done when stocks of the company are allotted to the employees after the employee is done with exercising his/her option on the completion of the vesting period.
The second levy is done when the employee opts to trade the allotted shares under the Employee Stock Option Plan.

ESOP taxation in India is done under the main salary (prerequisite) where the difference between the exercise value of shares and the fair cash value of the shares is taxed according to the general tax slab of the employee. The sale of such shares is subject to tax under capital gains where the difference between the exercise price and sale price is taxed at capital gains rates.

What Are The Tax Implications Of ESOP?

Employee stock options given by the company are free from the income tax deduction.
Vested options are also free from income tax deduction.
When the employees exercise buying shares of the company, the difference between the exercise of the share value and the share’s market value will be taxable depending on the income tax bracket the employees fall under.
If an employee of the company sells the shares held as capital gains, within a year, fifty percent of the tax is charged against the capital gains. On the other hand, if the employee trades the shares after a year, they are held as long-term resources and are free from the income tax deduction.
An employee who owns ESOPs in a foreign company will be subject to a short-term capital gains tax when the shares are sold. Without indexation, ten percent of the tax would be deducted, or twenty percent of the tax would be deducted.

Conclusion

An Employee Stock Option Plan or ESOP, is a strategic policy for employee remuneration given by listed companies. However, this scheme is subject to an income tax deduction and tax is calculated twice when an employee exercises the scheme and when the employee sells the shares.With the expertise of our talented pool of legal experts at Vakilsearch, we can help you register and provide ESOP plans for your employees in the right way!

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