Employee Stock Option Plan (“ESOP”) is an option granted to the employees to acquire certain number of shares allotted by the company, at a pre-determined price, at a future date. ESOPs are allotted only after fulfillment of certain conditions as specified in the ESOP policy drafted by the company. The tax implications of issuing ESOPs have been discussed below:
Tax liability for the Employees:
The tax liability for ESOPs arises only in two conditions:
1. When the shares are allotted to the employee:
1.1 The difference between the Fair Market Value (“FMV”) and exercise price of the shares are called perquisites.
1.2 As per Rule 3(8) of Income Tax Rules, 1962, where shares allotted are of listed company the FMV is the average of opening price and closing price. And if the shares allotted are of unlisted company then the FMV is the value determined by the merchant banker, registered with Securities Exchange Board of India (“SEBI”).
1.3 When shares are allotted, the difference between the market value of shares and exercise price is taxed as perquisites and is considered to be a part of income from salary. Tax liability arises only at the time of allotment of shares and not when the option was given to the employee.
2. When employee sells shares allotted to him:
2.1 Employees with ESOPs have an option to hold them or sell them. When shares are sold it attracts capital gains tax. Capital gains can be long term or short term, depending upon period of holding. This period of holding is calculated from the date of allotment of ESOPs.
2.2 In case of listed company, if shares are held for a period less than or equal to 12 months, the gains resulting out of sale of shares are short term capital gains. Where the shares are held for a period exceeding 12 months, the gains resulting out of sale of shares are long term capital gains.
2.3 In case of unlisted company, shares held for a period less than or equal to 24 months, the gains from such sale of shares are short term capital gains. Where the shares are held for a period exceeding 24 months, the gains resulting out of sale of shares are long term capital gains.
ESOPs being a great motivational tool for the employees of the company, it also attracts taxes depending upon the holding period, type of company and such other factors. Company issuing ESOPs have a good opportunity to make the employees stay with them for a longer period of time.
The content of this article is intended to provide general guidance on the subject matter. Specialist advice should be sought about your specific circumstances.