Explore key ESOP (Employee Stock Ownership Plan) terminology and tax implications. Understand grant dates, vesting periods, exercise prices, and taxation triggers. Make informed decisions on ESOPs for financial growth.
ESOP, or Employee Stock Ownership Plans, are unique employee benefit programs that provide employees with an opportunity to own a stake in the organization they work for. By offering eligible employees the right or option to purchase equity shares of the company at a predetermined rate within a specified timeframe, ESOP creates a sense of ownership and aligns the interests of employees with the long-term success of the organization. In this article, we will delve into the key aspects of ESOP and the terminology associated with it.
Understanding ESOP Terminology:
Grant Date: The grant date marks the agreement between the employer and the employee, granting the latter the option to own shares of the company at a later date. It serves as the starting point for the employee’s journey towards ownership.
Vesting Date: The vesting date signifies the point at which the employee becomes entitled to purchase the shares, subject to the fulfillment of previously agreed-upon conditions. It represents the culmination of the vesting period.
Vesting Period: The vesting period is the duration between the grant date and the vesting date. During this period, the employee must satisfy certain conditions, such as continued employment or achieving specific performance milestones, to become eligible to exercise the option to buy shares.
Exercise Date: The exercise date refers to the moment when the employee decides to exercise their option and purchase the shares. It typically occurs after the shares have vested, and the employee chooses to take advantage of the ownership opportunity.
Exercise Period: Once the shares have vested, the exercise period commences. This period provides the employee with a window of time to exercise their right to buy the shares, usually at a price lower than the fair market value.
Exercise Price: The exercise price is the predetermined price at which the employee can buy the shares when exercising their option. This price is often set below the fair market value of the shares, making it an attractive opportunity for employees to acquire ownership.
Taxation of ESOP’s
Tax is levied at two points in ESOP.
| First Trigger of ESOP taxation will be at the event of exercising ESOP | Second trigger will be at the time of sale of shares |
First Tax Trigger – When ESOP’s are Exercised – It will be taxable as part of Salary (Perquisite)
First Trigger – When ESOPs Are Exercised:
At the time of exercising ESOPs, the difference between the fair market value (FMV) on the exercise date and the exercise price is taxable as perquisite, which is treated as part of the employee’s salary. The employer deducts TDS (tax deducted at source) on this perquisite, and it is reflected in the employee’s Form 16 and included as part of the total income from salary in the tax return.
Important Note for Eligible Startups: An amendment in the Budget 2020 stated that from FY 2020-21, employees receiving ESOPs from eligible startups are not required to pay tax in the year of exercising the option. The TDS on the perquisite is deferred to the earlier of the following events: 1) expiry of five years from the year of ESOP allotment, 2) date of sale of the ESOP by the employee, or 3) date of termination of employment.
How to Calculate Fair Market Value (FMV) of Shares:
If the shares are traded on a recognized stock exchange on the exercise date, the FMV of the shares is the average of the opening and closing rates.
If the shares are not traded on a recognized stock exchange on the exercise date, the FMV of the shares is the closing price on the day preceding the exercise date.
If the shares are unlisted, the FMV of the shares is determined by a merchant banker.
Second Tax Trigger – When ESOP’s Are Sold – Capital Gains Tax will Apply
Taxability on Short-term or long-term capital gains:- Capital gains tax applies when ESOPs are sold. The taxability of capital gains depends on the period of holding the shares, which is calculated from the exercise date up to the date of sale.
For Listed Shares: Equity shares listed on a recognized stock exchange, where Securities Transaction Tax (STT) is paid on sale, are considered long-term gains if held for more than one year. If sold within one year, they are considered short-term gains.
For Unlisted Shares: Unlisted equity shares are considered long-term if held for more than two years. If sold within two years, they are considered short-term gains.
Taxation of Capital Gains
| Type of Shares | Period of Holding | Capital Gains | Tax Rate |
| Listed Shares | Less than or equal to 12 Months | Short Term Capital gains u/s 111A | 15% |
| Greater than 12 months | Long Term Capital Gains u/s 112A | 10% in excess of Rs.1 Lakh | |
| Unlisted Shares | Less than or equal to 24 Months | Short Term Capital gains | As per Income Tax Slab rate of the Employee |
| Greater than 24 months | Long Term Capital Gains u/s 112 | 20% without Indexation |
Taxation of Loss on sale of Shares under ESOP
Long-term capital losses on the sale of listed or unlisted shares can be set off against long-term capital gains and carried forward for up to eight years.
Short-term capital losses on the sale of listed or unlisted shares can be set off against both long-term and short-term capital gains and carried forward for up to eight years.
Disclosures under Income Tax Return:-
Income tax return forms now include several disclosures for foreign assets held. If an individual owns ESOPs of a foreign company, they may need to disclose their foreign holdings under Schedule FA of their income tax return. These disclosure requirements apply to resident taxpayers.
Conclusion:
ESOPs play a significant role in empowering employees by providing them with the opportunity to own a stake in the organization they work for. Through the key terms and terminology associated with ESOPs, employees can understand the process of ownership, including grant dates, vesting periods, exercise dates, exercise prices, and more. Additionally, being aware of the taxation aspects is crucial for employees, as it helps them navigate the potential tax implications of exercising and selling ESOPs.
The introduction of favorable tax provisions for eligible startups has further enhanced the appeal of ESOPs as a valuable employee benefit. The ability to defer tax payments on perquisites until specific triggering events provides employees with more flexibility and potential tax savings.
Calculating the fair market value of shares is an important step in determining the taxable value of ESOPs. Whether the shares are traded on recognized stock exchanges or are unlisted, understanding the valuation methods ensures proper compliance with tax regulations.
When it comes to selling ESOPs, employees need to consider the period of holding and the associated tax rates for short-term and long-term capital gains. Losses incurred on the sale of shares can also be utilized for future tax benefits, allowing individuals to offset capital gains and reduce their overall tax liability.
It is essential to remain aware of the disclosure requirements when it comes to foreign assets held in the form of ESOPs. Compliance with these requirements ensures that employees meet their tax obligations and avoid any potential penalties.
In conclusion, ESOPs are valuable tools for fostering employee engagement, aligning interests, and providing a sense of ownership. Understanding the key aspects, terminology, and taxation implications empowers employees to make informed decisions regarding their ESOPs, leading to both financial and professional growth. Consulting with tax professionals and staying updated with changes in laws and regulations ensures employees can maximize the benefits offered by ESOPs while fulfilling their tax obligations.
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Disclaimer: This article provides general information as of its preparation and is not intended to be updated with subsequent changes in the law. It serves as a news update, and Affluence Advisory does not assume any responsibility for any loss arising from actions or inactions taken based on the material contained in this article. It is recommended to seek professional advice based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement.
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