An Employee Stock Ownership Plan (ESOP) in India is a scheme that allows employees to acquire shares of their employer’s company at a predetermined price, often as a reward or incentive to align their interests with the company’s growth. ESOPs are widely used by startups and established companies to attract and retain talent. The taxability of ESOPs in India is governed by the Income Tax Act, 1961, with specific provisions and amendments, including those introduced in recent Finance Acts.
What is an ESOP
Definition: ESOPs are employee benefit plans that grant esmployees the option to purchase company shares at a discounted or predetermined price (exercise price) after a vesting period. They provide employees with an ownership stake, fostering motivation and retention.
Key Stages:
- Grant: The company offers the option to buy shares at a fixed price.
- Vesting: Employees must stay with the company for a specified period to become eligible to exercise the option.
- Exercise: Employees purchase the shares at the exercise price.
- Sale: Employees sell the shares, often at a higher market price, to realize gains.
Eligibility: As per Rule 12(1) of the Companies (Share Capital and Debentures) Rules, permanent employees in India or abroad are eligible, but independent directors or employees part of the promoter group cannot be issued ESOPs.
Taxability of ESOPs in India
ESOPs are taxed at two stages under the Income Tax Act, 1961:
1. Taxation at the Time of Exercise (Perquisite Tax)
When: Tax is triggered when the employee exercises the option and acquires the shares.
Taxable Amount: The difference between the Fair Market Value (FMV) of the shares on the exercise date and the exercise price is treated as a perquisite under Section 17(2)(vi). This is taxed as part of “Salary” income at the employee’s applicable slab rate.
FMV Determination:
- Listed Companies: FMV is the average of the opening and closing prices on the recognized stock exchange on the exercise date.
- Unlisted Companies: FMV is determined by a merchant banker or chartered accountant as per Rule 3(8) of the Income Tax Rules, 1962
- TDS: The employer deducts Tax Deducted at Source (TDS) on the perquisite value, reported in the employee’s Form 16.
Example:
- Exercise price: ₹50 per share
- FMV at exercise: ₹200 per share
- Shares: 100
- Perquisite value = (₹200 – ₹50) × 100 = ₹15,000
- Taxed at the employee’s slab rate (e.g., 30% + cess = ₹4,680 approx.).
Finance Act, 2020 Amendment for Startups:
For employees of eligible startups (as defined under Section 80-IAC, i.e., DPIIT-registered startups incorporated between April 1, 2016, and March 31, 2025, with turnover not exceeding ₹100 crore), the tax on perquisite can be deferred. The tax is payable within 14 days of the earliest of:
- Expiry of 48 months (4 years) from the end of the relevant assessment year.
- Date of sale of the shares.
- Date of termination of employment.
- This deferral reduces the immediate tax burden, as startup shares are often illiquid, and employees may lack cash to pay taxes upfront.
2. Taxation at the Time of Sale (Capital Gains Tax)
– When: Tax is levied when the employee sells the shares.
– Taxable Amount: The difference between the sale price and the FMV (used for perquisite tax at exercise) is treated as capital gains.
– Type of Capital Gains:
– Listed Shares:
– Short-Term Capital Gains (STCG): If sold within 12 months of exercise, taxed at 20% (plus surcharge and cess) as per Finance Act, 2024 amendments.
– Long-Term Capital Gains (LTCG): If held for more than 12 months, taxed at 12.5% (without indexation) on gains exceeding ₹1.25 lakh.
– Unlisted Shares:
– STCG: If sold within 24 months, taxed at the employee’s slab rate.
– LTCG: If held for more than 24 months, taxed at 20% with indexation benefits under Section 112.
– Example:
– FMV at exercise: ₹200 per share
– Sale price: ₹300 per share
– Shares: 100
– Holding period: 18 months (LTCG for listed shares)
– Capital gain = (₹300 – ₹200) × 100 = ₹10,000
– Taxable LTCG (if total LTCG > ₹1.25 lakh) = ₹10,000 × 12.5% = ₹1,250 (plus cess).
TDS and Reporting: No TDS is deducted on capital gains; employees must report and pay tax via their Income Tax Return (ITR) under Schedule CG. Advance tax may apply if capital gains exceed the basic exemption limit, payable in installments (June 15, September 15, December 15, March 15).
Special Considerations
Eligible Startups:
The tax deferment for perquisite tax applies only to startups certified by the Inter-Ministerial Board (IMB) under Section 80-IAC. Advocacy exists to extend this to all DPIIT-registered startups to reduce financial strain and attract talent.
Conditions for eligible startups include incorporation between April 1, 2016, and March 31, 2025, and turnover below ₹100 crore.
Non-Resident Employees:
ESOP perquisites are taxable in India based on the proportion of services rendered in India during the vesting period. Non-residents or not ordinarily residents may claim relief under Double Taxation Avoidance Agreements (DTAAs) if a Tax Residency Certificate (TRC) is provided.
Foreign ESOPs require disclosure in Schedule FA of the ITR if the employee is a resident. Non-disclosure may attract penalties under the Black Money Act, though non-reporting of foreign assets up to ₹20 lakh was de-penalized in Budget 2024.
Buyback of ESOPs:
If a company buys back unexercised options (common in unlisted startups), the income is treated as salary and taxed at slab rates, with TDS deducted by the employer.
Employer Deductions:
Employers can claim a deduction for ESOP expenses under Section 37(1) as employee compensation costs, as upheld in cases like CIT vs. Lemon Tree Hotels (2015) and Biocon Ltd. vs. DCIT (2020).
Summary Table
| Stage | Taxable Event | Tax Type | Tax Rate (Post-Finance Act, 2024) |
| Exercise of ESOP | FMV – Exercise Price | Perquisite (Salary) | Slab Rates+ cess |
| Sale of Shares (Listed) | Sale Price – FMV at Exercise | STCG (≤12 months) | 20% + cess |
| Sale of Shares (Unlisted) | Sale Price – FMV at Exercise | STCG (≤24 months) LTCG (>24 months) | Slab rates + cess 20% with indexation + cess |
Conclusion
ESOPs remain a powerful tool for employee retention and wealth creation, but their tax implications require careful planning. The Finance Act, time to time introduced major changes to ESOP taxation based on available data, though proposals for broader tax deferment and alignment with global standards are under discussion. Employees should:
Plan exercise and sale timing to optimize tax liability.
Report foreign ESOPs in Schedule FA if resident.
Consult tax professionals for compliance, especially for cross-border ESOPs or startup-specific deferrals.
