The concept of ESOPs or ESPPs has evolved with a sense of sharing ownership responsibilities with employees and retaining talent that is necessary to startups.

Nowadays, it is popular amongst startups to create an ESOP pool typically about 10% to 15% of the capital before fundraising as it is tax efficient and helps especially when a company has to attract and retain talent with minimal cash outflow.

Employee Stock Option Plan (ESOP)

In the case of ESOPs, eligible employees who meet specified criteria as per the company’s ESOP scheme will be offered the option on a grant date to buy the company’s stock after vesting period (specified time for which employee has to continue his service in the company). After meeting the vesting conditions if any employee can purchase the company's stock at a predetermined value, generally it will be offered at discounted price.

Sometimes in the case of group companies, employees of subsidiary companies will be offered with options of the parent company.

Employee Share Purchase Plan (ESPP)

It is similar to ESOP, however in these types of plans an employee will make some contribution generally up to 15% of his earnings, the money contributed towards the plan accumulates over a few months before the employee decides to purchase stock from the company at a discounted price.

Tax consideration

Tax liability will trigger at 2 stages in the hands of employee as detailed below:

 At the time of exercise

Difference between Fair Market Value (FMV)  as on the date of exercise and the amount recovered by the employee is considered as the benefit for the employee. So it is taxed as a perquisite or a part of salary income itself at the time of exercise. 

 At the time of subsequent sale or transfer

At the time of subsequent sale or transfer, the difference between actual sale considerations realized and FMV as considered in the previous step is treated as capital gain. Fair market value can be adjusted for index if the holding period of the share is more than 24 months in case of unlisted shares as it is considered as long term capital gain. 

Example:

Grant date: 1st April 2015
Maturity date: 1st April 2018
Number of options exercised: 700
Fair market value as on April 2018: INR 150
Amount collected from employee: INR 20

In this case on 1st April 2018 employee will be taxed on INR 91000, i.e.
700 shares * (150-20) as perquisite.
There will not be any tax implications on lapsed options.

Subsequently say if in October 2019 if employee further sell the share at INR 200 per share, then the employee has to pay a short term capital gain tax on INR. 35000 i.e.
700 shares * (200-150) (since he sold within 24 months of acquisition) 

ESOP Tax

Tax implications in the hands of employer

Amount treated as a perquisite upon exercise of option as detailed above, the employer has to consider the same as salary cost & deduct TDS on the same. One advantage here is that for a company it is considered as allowable expenditure for determining its liability.

Sometimes it may so happen that the benefit arising from an ESOP discount might be more than the salary of the employee itself, say the perquisite amount might be INR 13 lakhs, whereas cash payout might be INR 9 lakhs. In such situations, the company generally has to ensure proper documentation & put in place a system to deduct the number of exercised options for TDS compliance.

Considering such difficulties faced by the employees, an option is given to defer the tax liability on perquisites till 14 days from earlier of the below events instead of date of exercise of option.

  • Expiry of five years from the end of year of allotment of shares under ESOPs
  • Date of sale of the such shares by the employee
  • Date of termination of employment

However such option is available only for eligible start up holding Inter-ministerial Board Certificate (IMB certificate).

Date of allotment Date of sale Date of Termination of employment Expiry of 5 years Perquisite tax triggering event Perquisite tax triggering date
01-Oct-20 01-Jul-23 01-Jan-24 01-Apr-26 Date of sale 01-Jul-23
01-Oct-20 01-Feb-24 01-Jan-24 01-Apr-26 Date of Termination of employment 01-Jan-24
01-Oct-20 01-Oct-27 01-Oct-26 01-Apr-26 Expiry of 5 years 01-Apr-26

Cross border ESOP transactions

In the case of group companies that have global presence, an employee may migrate to work in different countries for deputation. Therefore, a situation may arise where residential status at the time of grant of ESOP might change at the time of exercise of option after vesting which leads to double tax of the same income.

Generally, global income will be taxed in the hands of residents after giving the credit for taxes paid in foreign country.

In such cases, ESOP perquisites are taxable in a country on the basis of the number of days of services rendered in the country. Below example may be considered for the clarity of the situation (this example is only taken for understanding of the concept, however legal provisions of both countries have to be looked in real situations)

Example:

If the resident employee of Indian parent company, say P. Ltd., is granted 500 ESOPs at INR 30 each in May 2020 which will vest after 4 years in April 2024. He migrates to Dubai on deputation basis to a subsidiary there in April 2023 and continues to be resident in Dubai till May 2020.

If the fair market value at the time of exercise of option is INR 150, then total perquisite of INR  60,000 (INR 120 * 500 shares) will be taxed both in India and Dubai proportionately based on period of service in each country. In this case an employee has worked 3 years in India & 1 year in Dubai. Accordingly INR 45000 will be taxed in India and INR 15000 will be taxed in Dubai.

Issues for consideration

  • In India, it will be challenging for the parent company to comply with TDS requirements as there may not be any other source of income of the employee at the time of exercise
  • At the time of subsequent sale of shares in the foreign country, it may not accept FMV on the date of acquisition as cost of acquisition. This may lead to double tax for the employee


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