Another important question pertains to the tax implications of ESOPs. Simply put, ESOPs come with dual tax implications.
- When the employee exercises their right to buy the company’s shares
- When the employee decides to sell their shares after purchasing them
1. Tax implications when purchasing the shares
As already mentioned, employees have the right to purchase shares post-vesting date, and this price is far lower than the share’s Fair Market Value (FMV) on that particular date. This difference in the price between the fair market value and the share’s exercise price is taxed according to the employee’s income tax slab rate.
Let us consider an example. Employee ‘X’ purchased 2000 shares at an exercise price of Rs. 50, while its FMV is Rs. 100. In this instance, the difference (perquisite value) is Rs. (100-50)*2000, which is Rs. 1 lakh. Assuming the employee falls in the upper end of the tax slab (30%), the tax payable will be 30% of Rs. 1 lakh, which is Rs. 30,000.
That said, the government has relaxed the tax implications for start-ups. Employees working in start-ups don’t have to pay taxes on the perquisite value in the year when they exercise the ESOP. Instead, the tax deducted at source (TDS) on ESOPs would be deferred to the following situations, whichever happens first:
- The completion of 5 years from the ESOP grant date
- Date of selling the ESOP (by the employee)
- Date when the employee leaves the organisation
2. Tax implications when selling the shares
What are the ESOP tax implications when selling the shares? The share’s FMV on the date when the share was exercised and the selling price are considered, and the difference between the two is subject to capital gains tax.
If the shares are sold within 12 months of purchase, they will attract a short-term capital gains tax of 20% (as per UB 2024 amendments). On the other hand, if they are sold after 12 months and the gains exceed Rs. 1.25 lakh, they will attract a long-term capital gains tax of 12.5%.
Let us consider an example. Let us assume the exercise date as July 31, 2023, with a fair market value of Rs. 200 per share. Employee ‘A’ sold 1000 shares on July 29, 2024, with the FMV being 250 per share. The difference is Rs. 50, and the total gains made would be 50*1000, which is Rs. 50,000. This amount will attract an STCG tax of 20%, which results in a tax liability of Rs. 10,000.
If the employee sold their shares in August 2024 at an FMV of Rs. 225 per share, the difference would be Rs. 25 per share. The total gains would be Rs. 25*1000, which is Rs. 25,000. This will not attract any LTCG tax, as the gains are less than the Rs. 1.25 lakh threshold. However, if the FMV in August 2024 was Rs. 350 per share, this would result in gains of (350-200)*1000, which is Rs. 1.5 lakh. From this, Rs. 25,000 would attract an LTCG tax of 12.5%, resulting in a total liability of Rs. 3,125.