Taxability of ESOPs – Must Read For Startups

In this article we would stress upon  “Taxability of ESOPs -  Must Read For Startups” . Companies mostly startups follow Employee Stock Option Plan (ESOP) to get the interest of the employees going and to keep them motivated. This was newly introduced to benefit both the company and the employees of the ESOP is an option given to the employees of the company to purchase the company’s shares at a discounted price than the present market price. This option is generally given to high-ranking employees of the company. There is a Lock-in-period involved wherein after the expiry of the vesting period the shares can be exercised. The price paid to purchase the shares is termed as cost of acquisition of the share. Treatment of Shares Trading In India, trading in shares and stocks and earning profits or losses is termed as Capital Gains or Loss. Now these gains or losses can either be classified as Long Term Capital Gains/Loss or Short Term Capital Gains/Loss depending upon the period of holding of the shares/stock. If a share or a stock is held for less than 1 year then it is termed as Short Term else wise it is considered as Long Term. Similarly, if the shares are listed in the Bombay Stock Exchange (BSE) or National Stock Exchange (NSE), Security Transaction Tax (STT) is charged on the transaction but if these are shares listed in Foreign Share Market or unlisted shares then STT is not charged. Further, STT cannot be claimed as a deduction or treated as an expense while calculating the cost of acquisition or sale proceeds. As per Income Tax Act 1961, tax liabilities on the Capital Gains are as follows:

Capital Gains STT Charged STT not Charged
Long Term Exempt 20% Special Rate
Short Term 15% Special Rate Normal Tax Slab

Also, Indexation can be done only on the Long Term Shares on which STT is not charged. Factors Determining Tax Liability of ESOP The following factors determine the taxability of ESOP.

  1. The company could either be a Foreign Company with its stock listed in foreign stock market or an Indian Company having its stocks listed in Indian stock market.
  2. The employee may either be a Resident in India or a Non-Resident Indian.
  3. Bonus shares received at a certain ration on the number of shares already held.
  4. The shares of the company may be sold within 1 year of purchase or later.

Thus, if a Foreign Company provides ESOP then STT is not charged on the transaction but when an Indian Company provides it employees with ESOP, STT is charged on the trading transaction. Further, for a Resident Indian taxes are liable on the global income earned while a NRI is liable to pay taxes in India on the Income deemed to accrue or received in India.  Thus, a NRI is only liable to pay tax on the capital gains arising on shares trading if the shares are of an Indian Company. Bonus shares are given to the current shareholders, in a certain ratio depending upon the number of shares held, free of cost. It is an incentive provided by the company in the form of shares by awarding the current shareholders. If such a share is sold then the cost of acquisition is considered to be Nil resulting the entire sale proceeds to be treated as Capital Gains. If an employee sales a share within a year of purchase of the share then short term capital gains or loss arises but if the share is sold after one year then it is a long term capital gains or loss.