Taxation for ESOP/RSU/Sweat Equity Shares/ESPP

1. Under which Head of Income ESOP is taxable.

ESOP is taxable under income from Salary under income tax act, 1961. ESOP is perquisite according to section 17 of income tax act, 1961.

According to section 17(2)(vi) of Income Tax Act, 1961

“the value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at concessional rate to the assessee.”

According to above mentioned provision any security allotted by employer or former employer free of cost or concessional rate is considered as perquisite. Definition of security is very wide according to clause (h) of section 2 of The Securities Contract (Regulation) Act, 1956. This definition includes Debentures, Shares, Scrips, bonds, debenture stock, derivative, government securities, rights in shares and scrips etc. accordingly any scrips, shares, bonds, debenture given by employer to employee at free of cost or at concessional rate is considered as perquisites.

ESOP is taxable at two instances. First instance is explained in above paras which is on exercising of ESOP second instance is on sale or transfer of ESOP. In case of Transfer of ESOP it will be taxed under Head Capital Gain.

2. How to Value ESOP as a perquisite.

ESOP is valued at fair market value of shares or securities allotted to employees as on exercise date of shares or securities. Rule 3 of Income tax rules, 1962 provides details about how to value fair market value of shares or securities as a perquisite.

There is two type of shares for which different methods are provided about how to calculate value of ESOP.

I. Fair market value of Shares listed on recognised stock exchange on date of exercising option.

Fair market value for the shares listed on recognised stock exchange is average of opening and closing price on date of exercising option at stock exchange.

If shares are listed on multiple stock exchange in that case average value of stock exchange which had more volume of shares trading will be considered.

If on date of exercising option there is no trading in shares on any recognised stock exchange than closing price of the day closest to day of exercising the share should be considered.

II. Fair market value of unlisted shares or shares which not listed on recognised stock exchange.

Fair market value will be value determined by merchant banker on date of exercising the option will be considered.

3. Capital Gain for sale or transfer of shares received in ESOP.

For degerming Capital Gain following details are required

i. Cost of Acquisition of Capital Asset

ii. Period of Holding of Capital Asset

With respect to ESOPs Cost of acquisition is Fair market of shares or securities taken in consideration for calculation of Perquisites under head salary according to section 17(2)(vi).

Period of holding of ESOP will be from date of exercising of option to transfer of shares or securities. Whether Capital gain is short term or long term will be decided on the basis of nature of capital asset i.e. listed on recognised stock exchange, unlisted shares, STT is paid or not on transfer etc.

Period of Holding Nature of Capital Asset STCA or LTCA

Less than 12 Months i. Securities Listed on Recognised stock exchange

ii. Zero Coupon Bond

iii. Unit of equity oriented fund / unit of UTI STCA (Short Term Capital Asset )

If holding period is more than 12 Moths than LTCA (Long Term Capital Asset)

i. Less than 24 Months i. Unlisted Shares

ii. Land or Building or both STCA

If holding period is more than 24 Moths than LTCA

i. Less than 36 Months i. Unit of Debt oriented fund

ii. Unlisted Securities other

iii. than shares

Other Capital Assets STCA

If holding period is more than 36 Moths than LTCA

Capital Gain of ESOP will be calculated in following way.

A. Sales Consideration Received.

B. Less: Cost of Acquisition i.e. Fair Market Value of Shares on Exercise Date which is considered as Perquisites

4. Whether There is any benefit or incentive is Given to employees of Start-ups for Taxation of ESOP.

Budget 2020 was come up with new amendment for taxation ESOPs for Start-ups. Section 192 is amended according to which eligible star-up referred to in Section 80-IAC of income tax act, 1961 Employer is not required to deduct or pay TDS till the Fourteen Days from Earlier of following any event

A. Expiry of 48 Months from the end of Assessment Year for which ESOP is exercised

B. Sale of ESOP

C. Employee Leaving the Organisation

By this amendment taxation of ESOP is deferred by which working capital can be maintained by the employee and no other benefit is granted to employees of eligible start-up. That means previously employee has to pay tax on exercising of ESOP and Transfer of ESOP but now on sale of ESOP or on leaving of organisation or 48 Months from exercising of ESOP they have to pay Tax.

Various Definitions or Meaning of words

“specified security” means the securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and, where employees’ stock option has been granted under any plan or scheme therefor, includes the securities offered under such plan or scheme;

“sweat equity shares” means equity shares issued by a company to its employees or directors at a discount or for consideration other than cash for providing know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called;

the value of any specified security or sweat equity shares shall be the fair market value of the specified security or sweat equity shares, as the case may be, on the date on which the option is exercised by the assessee as reduced by the amount actually paid by, or recovered from, the assessee in respect of such security or shares;

“fair market value” means the value determined in accordance with the method as may be prescribed; i.e. according to Rule 3 of Income Tax Rules, 1962

“option” means a right but not an obligation granted to an employee to apply for the specified security or sweat equity shares at a predetermined price;

Perquisite means a benefit which one enjoys or is entitled to on account of one’s job or position Recognised Stock Exchange means a stock exchange which is for the time being recognised by the Central Government under section 4 of SECURITIES CONTRACTS (REGULATION) ACT, 1956. – Section 2(f) closing price of a share on a recognised stock exchange on a date shall be the price of the last settlement on such date on such stock exchange.

Provided that where the stock exchange quotes both “buy” and “sell” prices, the closing price shall be the “sell” price of the last settlement merchant banker means category I merchant banker registered with Securities and Exchange Board of India established under section 3 of the Securities and Exchange Board of India Act, 1992 (15 of 1992) opening price of a share on a recognised stock exchange on a date shall be the price of the first settlement on such date on such stock exchange.

Provided that where the stock exchange quotes both “buy” and “sell” prices, the opening price shall be the “sell” price of the first settlement;

Grant Date means The date of agreement between the employer and employee to give an option to own shares (at a later date ).

Vesting Date means The date the employee is entitled to buy shares, after conditions agreed upon earlier are fulfilled. This date is also the agreed-on grant date.

Vesting Period means The time period between the grant date and vesting date

Exercised Period means Once stocks have ‘vested’, the employee now has a right to buy (but not an obligation) the shares for a period of time. This period is called exercise period.

Exercised date means The date on which employee exercises the option.

eligible start-up means a company or a limited liability partnership engaged in eligible business which fulfils the following conditions, namely:—

(a) it is incorporated on or after the 1st day of April, 2016 but before the 1st day of April, 2023

(b) the total turnover of its business does not exceed [one hundred] crore rupees in the previous year relevant to the assessment year for which deduction under sub-section (1) is claimed; and

(c) it holds a certificate of eligible business from the Inter-Ministerial Board of Certification as notified in the Official Gazette by the Central Government;