Balwant Jain

Balwant JainAlmost all of you must have heard the stories of many drivers, office assistants and secretaries of Infosys becoming millionaire. This all  could become possible due to a system of making such stakeholders as stockholder of the Company by granting them what is generally known as ESOP (Employee Stock Options Plan). In this article,  I intend to discuss various aspects related with ESOP.

 What is ESOP

ESOP is a system under which generally the employees are given a right to acquire shares of the Company for which they are working. In some of the cases the foreign holding/subsidiary Company also grants such options to the employees of the Indian Subsidiary/holding company.  Under such scheme the employees are granted some rights called as stock options to get shares of the Company at free or at concessional rate,  at a predetermined price or the price to be determined on the prefixed method,. as compared to the potential market rate.

Why ESOPs are given

There are various reasons for which the employees are given such stock options. The phenomena of stock options is more prevalent in start up companies which can  not afford to pay huge salaries to its employees but is willing to share the future prosperity of the Company. In such cases the employees are given the stock options as part of the compensation package. Moreover in some  of the cases the employee is given such stock options which he can exercise in future date/s,  in order to ensure long term commitment of the employee.  So Apart from rewarding the employees with monetary gains, ESOP also help  create a  sense of belonging and ownership amongst the employees.

Understanding vesting date and grant price

Under the ESOP schemes the stock option is free when it is given to an employee. The terms and conditions on which employee can exercise his rights are spelt 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.

The right to exercise the option may get vested in the employee in the next future date/s. The dates on which the employee becomes entitled to exercise the right to acquire the shares is called as “vesting date”  The rights may vest fully or partially over the vesting period. For example an employee is given 1000 options on 31st March, 2017 which can be exercised in phases like  20% on completion of one year, 30% on completion of second year and the balance on completion of third year from the date of such grant.  So in the instant case the  vesting dates for 200 options is 1st April, 2018,  for 300 shares it is 31st March 2019 and for balance  500 shares it is 31st March 2020. The plan may stipulate same or different grant price or exercise price for such vesting. The grant price or the price at which the employee can buy the share from the company are generally fixed and is generally substantially lower than the prevailing market price of the shares in case the shares are listed.

Since the employee is given just an option without any obligation attached to it, it is not mandatory for the employee to exercise the option. The employee may decide to exercise the option or may decide to let the option lapse in case the prevailing price of the shares is lower than the exercise price. The employee is given a time period during which the he has to exercise the option failing which the vested rights may lapse. The date on which the employees exercise his option to buy the shares is known as ‘exercise date’.

There are no cash outflow or taxation implications when the options are granted as well as when the options are vested in the employee.

When to exercise options.

It is not necessary for an employee to exercise the option once it vests with him. The employee can exercise the right within stipulated time period.  When the employee should exercise the options is very important question from financial and taxation angle as well. Once the employee exercises the option,  he has to pay for the shares at the price predetermined and thus causing cash outflow. In case the shares are not listed on stock exchange, the same can not be liquidated and thus the money gets locked till the shares get listed or the promoters offer you an exit option. Moreover there is taxation implication if you delay your exercise date because the holding period for capital gain purpose will start from the exercise date. So the decision has to be taken after having considered cash flow and taxation implications of such decision.

The tax implications when exercising the option:

The taxation of ESOP has a typical structure. It is taxed in two stages. First stage is when the employee exercises the option to buy the shares at the exercise price. The second stage is when the shares are in ultimately sold.

Let us first discuss the first stage. As and when the options under the ESOPs are  exercised, 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. The certificate of valuation of shares should not be older than 180 days from the date of exercise of the option. Even if the shares are listed outside India, the Company will have to obtain the certificate from Merchant Banker as such shares are treated as unlisted shares for ESOP purposes.

The tax implication when the shares acquired under ESOP are disposed off

Now let us understand the second leg of the taxation of the ESOP shares i.e. when the employee actually sells the shares. 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. The holding period requirement are different for listed shares as well as for unlisted shares. The listed shares shall become long term if held for more than one year.. For unlisted shares the same shall become long term after three years.


i) With effect from Assessment Year 2017-18, period of holding to be considered as 24 months instead of 36 months in case of unlisted shares of a company,

ii) With effect from A.Y. 2018-19, period of holding to be considered as 24 months in instead of 36 months in case of immovable property being land or building or both.

iii) Period oh holding for debt oriented mutual fund(listed/unlisted) to qualify as lon term assets shall be more than 36 months

The rate at which the short term or long term gains shall be taxed will depend on whether the shares have been traded on the platform of stock exchange on which the Security Transaction Tax has been paid. In case shares are traded through broker the long term capital gains are fully exempt under Section 10(38) of the income tax Act.  However as per the newly inserted section 112A via Finance Act 2018, if the amount of long- term Capital gain exceeds Rs 1,00,000 than the amount in excess of Rs 1,00,000 shall be chargeable to tax @ 10% without indexation  (plus  heath and education cess and surcharge). However the application of sec 112A is subjected to certain conditions, one of it being the transfer should have taken place on or after 1st April ,2018. Moreover such short term capital gains shall be taxed @ flat rate of  15% under Section 111A.

However in case the shares are not sold through the platform of the stock exchange, the long term capital gains shall be calculated after applying the indexation to the original cost of purchase. Indexed gains so calculated shall be taxed @ flat rate of 20% plus applicable surcharge and education cess. Such short term capital gains are  be treated like any other income and added to other income and taxed at the slab rate applicable.

For the purpose of computing the capital gains the fair market value as on the date of exercise,  taken into account for the purpose of perquisites of the options,   is treated as the cost of acquisition and not the price actually paid by the employee.

The tax implications would be different in case the ESOPs are allotted to a person who is not an employee either by the holding or subsidiary company or the any non executive director or any other eligible person. The question of it being taxed as perquisite does not arise when the option is exercised by such persons however the capital gains tax will have to be paid as and when such shares are sold.

Taxation of Foreign ESOPs

In case the ESOP are granted by Foreign Companies to Indian resident, the same would be taxable in India. Moreover the taxation provisions of the country of the company which grants the option as well the double taxation avoidance agreement shall have to be looked into for understanding the exact tax implication. Moreover the exemption of long term capital gains under Section 10(38) or concessional rate of 15% tax on short term capital gain in respect of such shares would not be available as these shares would not be sold on Indian stock exchanges as these are not likely to be listed in India.

When Should you sell the shares?

The decision to sell the shares acquired under ESOP is like any other investment decision. You need to take into account the capital gains implication as well as the need for liquidity for arriving at the decision. Moreover whether and when to sell decision will also depend on the future prospects of the Company. It may also happen that the shares which you have acquired under ESOP are not listed, so in such situation you can not sell the shares until the shares are listed or the promoters offer you an exit, which may not be at very attractive terms. In such a situation, it will make sense for you to wait a little till the shares are listed on stock exchange.

Should you accept ESOPs in lieu of cash as part of salary?

As the old saying goes “one in hand is better than two in bush” common sense would demand that one should opt for cash in lieu of the ESOPS but here such comparison may not be so easy to make as regards the bird in hand and one in bush because generally the projected price of the shares under ESOP plan may be significantly higher than the cash component being offered. More such an option to chose cash in lieu of ESOP may not always be available.

I am sure all the discussion above would help you the concept and taxation implication of ESOPS.

Balwant Jain is a tax and investment expert. He can be reached on, @jainbalwant

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(Republished With Amendments)

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  1. Bhavik Mehta says:

    Dear Sir,

    Thanks for this detailed article.
    Request to please guide what amount of Expense is deductible in the hands of Company ?
    Is it only on discount calculated on market price as on the date of ESOP Scheme launched or it is based on actual discount given to employees i.e. on the date of exercise of shares Options?

  2. K. Bhaskar says:

    Sir what about the tax implication if the employee decides to swap the stocks i.e he passes the rights to a new investor who pays the difference to the employee (Current buying price – exercise price) while the excercise price is paid to the company as share capital plus premium?

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February 2024