Important keyword: Capital Gains, ETF, ITR-2, Trading Income.
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ETF: Exchange Traded Fund
Exchange-traded funds (ETFs) made their debut in India in 2002, offering investors a diversified and cost-effective investment option. Unlike investing in individual stocks, where the risk is concentrated in a single company, ETFs allow investors to spread their risk across multiple companies within a specific sector or index.
Compared to mutual funds, ETFs offer several advantages, including lower expenses and higher liquidity. ETFs typically have lower expense ratios compared to mutual funds, making them a cost-effective option for investors. Additionally, since ETFs are traded on stock exchanges like individual stocks, investors can buy and sell them throughout the trading day at market prices, providing greater liquidity compared to traditional mutual funds.
Overall, ETFs provide investors with a convenient and efficient way to gain exposure to a diversified portfolio of assets while enjoying the benefits of lower costs and increased liquidity.
ETF: Meaning
Exchange-traded funds (ETFs) are investment vehicles that mirror the composition of an index, such as the BSE Sensex or CNX Nifty. They hold a diversified portfolio of stocks in proportions similar to those of the underlying index. ETFs are listed and traded on stock exchanges, allowing investors to buy and sell them throughout the trading day at market prices, similar to individual stocks.
There are various types of ETFs based on the securities they invest in:
Equity ETFs: These invest in equity shares and related instruments.
Debt ETFs: These invest in fixed-return securities like bonds and debentures.
Gold ETFs: These invest in physical gold assets.
Currency ETFs: These invest in currency instruments.
Tax treatment of income from ETFs is similar to that of mutual funds:
Capital gains on the sale of ETFs are taxed as follows:
For Equity ETFs:
Long-term capital gains (LTCG): Gains from holding equity ETFs for over 12 months are taxed at 10% above INR 1,00,000.
Short-term capital gains (STCG): Gains from holding equity ETFs for less than 12 months are taxed at 15%.
For Other ETFs (where less than 35% of funds are invested in equity shares of domestic companies):
For ETFs acquired after April 1, 2023: LTCG is taxed at applicable slab rates, as indexation benefits are no longer available.
For ETFs acquired before April 1, 2023:
LTCG: Gains from holding other ETFs for over 36 months are taxed at 20% with indexation benefit.
STCG: Gains from holding other ETFs for less than 36 months are taxed at slab rates.
Other Income from ETF (Exchange Traded Funds)
Interest Income:
Interest income is considered taxable income under the head “Income From Other Sources” (IFOS) and is taxed at slab rates. This includes interest earned from bank deposits, fixed deposits, savings accounts, bonds, etc.
Dividend Income:
In the case of dividend income, the tax treatment depends on the fiscal year:
Up to the financial year 2019-20: Dividend income was exempt from tax.
From the financial year 2020-21 onwards: Dividend income is treated as taxable income under the head “Income From Other Sources” (IFOS) and is taxed at slab rates. This applies whether the dividend is reinvested in the scheme or distributed to investors.
Income Tax on ETF (Exchange Traded Funds)
Income Tax on Trading in ETFs is similar to the tax treatment of mutual funds. The following are the income tax rates:
Type of ETF
Period of Holding
Long-Term Capital Gain
Short-Term Capital Gain
Equity ETF
12 months
10% over INR 1,00,000 under Section 112A
15% under Sec 111A
Other ETF
36 months
Slab Rate
Slab Rates
ITR Form, Due Date and Tax Audit Applicability for ETF Investors
ITR Form:
Traders should file ITR 2 (ITR for Capital Gains Income) on the Income Tax Website since income from the sale of ETFs is considered Capital Gains Income.
Due Date:
Up to the financial year 2019-20:
31st July: For traders not subject to Tax Audit.
30th September: For traders subject to Tax Audit.
From the financial year 2020-21 onwards:
31st July: For traders not subject to Tax Audit.
31st October: For traders subject to Tax Audit.
Tax Audit:
As income from the sale of ETFs is considered Capital Gains Income, taxpayers do not need to determine the applicability of tax audit under Section 44AB.
Carry Forward Loss for sale of ETFs
Gain or loss on the sale of ETFs is classified as either Capital Gain or Capital Loss. Here are the rules for setting off and carrying forward losses on the sale of ETFs:
Short Term Capital Loss (STCL):
STCL can be set off against both Short Term Capital Gain (STCG) and Long Term Capital Gain (LTCG).
The remaining loss can be carried forward for up to 8 years and set off against STCG and LTCG only.
Long Term Capital Loss (LTCL):
LTCL can be set off against Long Term Capital Gain (LTCG) only.
The remaining loss can be carried forward for up to 8 years and set off against LTCG only.
Important Keyword: Capital Gains, ITR-2, Trading Income, Unlisted Shares.
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Tax on Unlisted Shares
Investing in unlisted shares means buying ownership stakes in companies that haven’t gone through the process of making their shares available for public trading through an Initial Public Offering (IPO). Unlike shares of listed companies that are traded on stock exchanges, unlisted share is not accessible to the general public for buying and selling. Consequently, determining their value and understanding the tax implications can be more complex compared to publicly traded shares.
Unlisted shares are typically bought and sold through private transactions or platforms known as over-the-counter (OTC) markets. In these scenarios, buyers and sellers negotiate directly, and there is often less transparency and liquidity compared to trading on stock exchanges.
When it comes to taxation, the gains or profits made from selling unlisted shares are subject to capital gains tax, similar to listed shares. However, determining the cost of acquiring these shares and establishing their fair market value can pose challenges, especially since there isn’t a readily available market price. Investors may need to employ various valuation methods, such as the net asset value approach or discounted cash flow analysis, to assess the worth of unlisted shares for tax purposes.
Furthermore, investors should be aware of the tax implications associated with the duration of their investment, as different tax rates may apply depending on whether the gains are categorized as short-term or long-term capital gains.
While investing in unlisted share can offer opportunities for portfolio diversification and potentially higher returns, it’s essential for investors to carefully evaluate the risks and complexities involved, including valuation challenges and tax considerations, before making investment decisions in this domain.
What are Unlisted Shares?
Unlisted shares represent ownership in companies not traded on recognized stock exchanges. Unlike their listed counterparts, which are openly traded, unlisted shares are typically held by private entities like startups or privately-owned firms. Individuals investing in these shares often include founders, early backers, or employees of the company.
While unlisted shares offer potential returns, they come with unique considerations and risks. Valuing them can be subjective, and finding buyers for these shares may be challenging due to limited market activity. Additionally, compared to publicly traded companies, information about unlisted firms may be less accessible.
Taxation on the sale of unlisted shares differs from that of listed shares due to the absence of Securities Transaction Tax (STT) since they are not traded on recognized stock exchanges. For determining tax liability, the holding period for unlisted shares is considered 24 months:
Long-Term Capital Gain (LTCG): Profits from selling unlisted share held for over 24 months are classified as LTCG.
Short-Term Capital Gain (STCG): Gains from selling unlisted share held for up to 24 months are treated as STCG.
Income Tax on Unlisted Shares
Capital Gains
Holding Period
Taxability
Short Term Capital Gains
< 24 Months
Slab rates
Long Term Capital Gains
> 24 Months
20% under section 112
For the calculation of capital gains on unlisted shares, determining the sales consideration and purchase value is crucial.
Sales Consideration:
The Fair Market Value (FMV) dictates the sale value of unlisted share, regardless of market conditions. If the transfer occurs below the FMV, section 50CA of the Income Tax Act mandates using the FMV as the sales consideration. Conversely, if the transfer happens at or above the FMV, the original transfer value is considered.
Sales consideration = Higher of Actual sales value or FMV as on the date of transfer
Cost of Acquisition:
The purchase value for unlisted share is the actual price paid by the investor during the purchase. Moreover, the benefit of Indexation is applicable for unlisted shares.
Let’s illustrate this with an example:
Mr. Swapnil acquired unlisted share for INR 10,000 on 30th September 2020 and sold them for INR 15,000 on 31st December 2023. The FMV on the sale date was INR 14,000. Since the actual transaction price exceeds the FMV, the sales consideration is INR 15,000. Additionally, as the holding period exceeds 24 months, the shares qualify as long-term capital assets.
Particulars
Amount (INR)
Sales Consideration Higher of: Actual sale value i.e.150 or, FMV on date of sales i.e. 140
15,000
Purchase Value
10,000
Indexed Purchase Value
11,561
Long Term Capital Gains (15,000 – 11,561)
3,439
Tax @20% under section 112
688
ITR Form, Due Date, and Tax Audit Applicability
For reporting income from the sale of unlisted stocks, traders should file ITR 2, specifically designed for capital gains income.
The due dates for filing income tax returns are as follows:
July 31st: For traders not subject to tax audit
October 31st: For traders subject to tax audit
Tax Audit is not applicable for income from the sale of unlisted stocks as it falls under capital gains income. Therefore, traders are exempt from tax audit requirements in this regard.
Carry Forward Loss on Sale of Unlisted Shares
Investors have the flexibility to set off short-term capital losses against both short-term and long-term capital gains. Any remaining loss after set off can be carried forward for up to 8 years and utilized against both short-term and long-term capital gains within this period.
Long-term capital losses, on the other hand, can only be set off against long-term capital gains. Similarly, any unabsorbed long-term capital losses can be carried forward for up to 8 years and utilized against long-term capital gains during this period.
Important Keyword: Capital Gains, Exempt Income, Income Interest, Income Source, Provident Fund.
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Exempt Income u/s 10 of the Income Tax Act
It’s a common misconception that any income earned is subject to taxation. However, certain types of income fall under the category of Exempt Income according to section 10 of the Income Tax Act, meaning there’s no tax liability on them. Exempt income can take various forms, such as interest received from PPF or agricultural land, among others.
What is Exempt Income?
Exempt income pertains to specific types of earnings that are not taxable under the Income Tax Act’s provisions. This differs from deductions under income tax, where deductions are claimed against taxable income. In essence, exempted incomes are excluded from a taxpayer’s total taxable income, while deductions are applied to taxable incomes.
Types of Exempt Income
Agriculture Income:
Income derived from agricultural activities is exempt from taxation under the Income Tax Act. However, this income must be accounted for in the total income calculation to determine the applicable tax slab rates. As a result, it indirectly impacts taxation by potentially pushing non-agricultural income into higher tax brackets.
Gifts from Relatives:
Gifts received from relatives are not subject to taxation. This exemption extends to gifts received during marriage ceremonies or through wills. Additionally, monetary gifts from non-relatives up to INR 50,000 are also exempt from tax.
Long Term Capital Gains:
As of the financial year 2018-19, long-term capital gains (LTCG) up to INR 1,00,000 are not taxable. Previously, gains from the sale of stocks and equity mutual funds were exempt from tax under section 10(38), though this provision does not apply to debt mutual funds.
Interest on Securities:
Income from securities such as interest and premium received from government-issued bonds, certificates, and deposits is tax-free. This includes bonds issued by entities like NHAI, IRFC, and REC.
Profit Share from Partnership Firms:
The share of profits from a partnership firm or LLP is exempt from tax in the hands of the partner. However, interest on capital and remuneration received may be taxable.
Provident Fund:
Payments received from Provident Fund (PF) are exempt under Section 10. However, withdrawals from PF before completing five years of service may be taxable. For EPF, withdrawal is permissible under certain conditions.
Gratuity:
Gratuity received by government employees is tax-free. In the case of private organization employees, gratuity is exempt from tax subject to specific conditions.
Commuted Pension:
Commuted pension received by government employees is entirely tax-free. Other employees may also enjoy tax exemption on commuted pension subject to certain conditions.
Other Exempt Income
Life Insurance:
Payments received from a life insurance policy are exempt from tax under section 10(10D) of the Income Tax Act. This exemption applies to both the maturity amount and death claims.
Receipts from HUF:
Any funds received from the family income are tax-free for the member of a Hindu Undivided Family (HUF). For instance, if a family owns an impartible estate, any amount received by a member from the family estate’s income is exempt from tax.
Scholarships and Awards:
Scholarships or awards granted to deserving students to cover educational expenses are exempt from tax. The entire scholarship amount receives this tax exemption.
Amount Received under VRS (Voluntary Retirement Service):
Employees receiving amounts under voluntary retirement schemes, as per Rule 2BA of the Income Tax Rules, are eligible for tax exemption of up to Rs. 5,00,000 from the retirement amount received.
Allowance for Foreign Services:
Indian residents providing services outside the country and receiving allowances or perquisites abroad are exempt from income tax under section 10(7) of the Act. This provision ensures that allowances and perquisites received by government servants while working overseas remain tax-free.
Reporting of Income in ITR
Taxpayers can disclose their exempt income when filing their income tax returns each year. Exempt income should be reported in the “Exempt Income” section under the “Computation of Income and Tax” tab in ITR-1 and ITR-4. By adding a row, selecting the nature of income from the dropdown list, and entering a description and amount, taxpayers can accurately report their exempt income.
For ITR-2 and ITR-3, taxpayers should report non-taxable income under Schedule EI, which stands for Schedule Exempt Income. Details should be provided for various types of exempt income, including Interest Income, Agriculture Income, Income not chargeable as per DTAA, and other exempt income, selecting the relevant option from the dropdown list. This income is reported separately and not included in the Gross Total Income.
Disclosure of Exempt Income for Salary and Non-Salary Allowances
For individuals with salary income, exempt income should be disclosed under Schedule S – Details of Income from Salary when filing income tax returns using ITR-2. Various exemptions such as House Rent Allowance (HRA), Leave Travel Allowance (LTA), Leave Encashment Amount, Pension Amount, Gratuity Amount, and any perquisites received, including amounts received from a Voluntary Retirement Scheme, should be reported here.
For self-employed individuals or those without salary income, certain incomes fall under the category of exempt income. These include agricultural income, interest on funds, and other income, which must be disclosed under Schedule EI while filing income tax returns.
Important Keyword: Capital Gains, Income from House Property, Income Source.
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What is Capital Gain?
Capital Gain is simply the profit or loss that arises when you transfer a Capital Asset. If you sell a Long Term Capital Asset, you will have Long Term Capital Gains and if you sell a Short Term Capital Asset, you will have a Short Term Capital Gain. If the result from the sale is negative, you will have a capital loss. The Capital Gain will be chargeable to tax in the year in which the transfer of capital assets takes place.
What is a Capital Asset?
A capital asset encompasses any property you own, regardless of its connection to your business or profession. This includes movable and immovable assets, tangible and intangible assets, rights, and choices in actions. Examples of capital assets include house property, land, buildings, goodwill, patents, trademarks, machinery, jewelry, cars, and paintings.
However, certain assets are excluded from the definition of capital assets:
Stock in trade, consumables, or raw materials held for business or professional purposes.
Personal effects like clothing or furniture held for personal use.
Agricultural land situated outside specified areas based on population density.
Gold Bonds, Special Bearer Bonds, and Gold Deposit Bonds issued by the Government of India.
The term “transfer” refers to any action that leads to the profit or gain from a capital asset, constituting a capital gain. Transfer includes:
Sale, exchange, or relinquishment of the asset.
Extinction of any rights in the asset.
Compulsory acquisition of an asset.
Conversion of a capital asset into stock in trade.
Maturity or redemption of zero coupon bonds.
Any other transaction affecting the possession or enjoyment of an immovable property.
Transactions involving gift, will, or inheritance of a capital asset are not considered transfers for tax purposes. Additionally, if the asset transferred is not a capital asset, the provisions of capital gains tax do not apply.
What is Long Term and Short-Term Capital Asset?
Yes, the classification of assets as short-term or long-term capital assets depends on the duration of ownership before their sale. Typically, assets held for 36 months or less are considered short-term, while those held for more than 36 months are categorized as long-term.
However, there are exceptions to this rule:
Equity shares or preference shares, debentures or government securities, units of UTI, units of equity-oriented mutual funds, and zero-coupon bonds are treated as short-term capital assets if held for 12 months or less. If held for more than 12 months, they are classified as long-term capital assets.
Other assets, not falling under the exceptions mentioned above, follow the general rule of 36 months for determining short-term or long-term status.
It’s essential to recognize these distinctions, as the tax implications vary based on whether the gains or losses arise from short-term or long-term capital assets. The table given below defines period of holding for different classes of asset in order to be classified as short term or long term:
Asset
Period of holding
Short Term / Long Term
Immovable property
< 24 months
Short Term
>24 months
Long Term
Listed equity shares
<12 months
Short Term
>12 Months
Long Term
Unlisted shares
<24 months
Short Term
>24 months
Long Term
Equity Mutual funds
<12 months
Short Term
>12 months
Long Term
Debt mutual funds
<36 months
Short Term
>36 months
Long Term
Other assets
<36 months
Short Term
>36 months
Long Term
Note: Determination of period of holding is important because it impacts the method of calculating Capital Gains and also the tax rates.
How to determine the holding period if the asset was gifted?
When calculating Capital Gains, various factors come into play, depending on whether the asset is categorized as a Long Term or Short Term Capital Asset. Here’s a breakdown of key terms and concepts involved in the process:
Full Value of Consideration:
This refers to the total amount received or expected to be received by the seller upon transferring the asset to the buyer. Capital Gain is taxable in the year of transfer, regardless of when the consideration is received.
Cost of Acquisition:
The cost at which the seller initially acquired the asset is known as the Cost of Acquisition.
Cost of Improvement:
Any expenses incurred for improving, repairing, or enhancing the asset after April 1, 1981, are considered as the Cost of Improvement. These costs are factored in when determining the Capital Gain.
Indexation:
Indexation involves adjusting the cost of acquisition and improvement using the Cost Inflation Index (CII) notified by the Central Government annually. This adjustment accounts for inflation, ensuring that the purchasing power of the asset remains intact over time.
Additionally, it’s important to consider certain scenarios that impact the calculation of the holding period:
In cases where the asset was received as a gift, inheritance, or through succession, the holding period of the previous owner is also included in the total holding period for the current owner.
For bonus shares or right shares, the holding period is calculated from the date of their allotment.
How to Calculate Short Term Capital Gains Tax?
Particulars
Amount
Full Value of Consideration
XXXX
Less: Expenditure incurred exclusively in connection with the transfer. Cost of Acquisition. Cost of Improvement.
(XXX)
(XXX) (XXX)
Less: Exemption under Section 54B
(XXX)
Short Term Capital Gain (1-2-3)
XXXX
How to Calculate Long Term Capital Gain Tax?
Particulars
Amount
Full Value of Consideration
XXXX
Less: Expenditure incurred exclusively in connection with the transfer. Index* Cost of Acquisition. Index* Cost of Improvement.
Can I claim any expenses as a deduction from the full value of consideration?
Yes, you can claim certain expenses as deductions from the full value of consideration when calculating Capital Gains. These expenses must be directly related to the transfer of the property. Here’s a breakdown of allowable expenses for different types of sales transactions:
Sale of Shares/Stocks:
Brokerage or sales commission paid to brokers or agents.
Note that Securities Transaction Tax (STT) is not allowed as a deduction.
Sale of House Property:
Commission or brokerage paid to property agents or brokers.
Stamp duty paid on the transfer of property.
Any travel expenses incurred to facilitate the sales transaction.
Legal charges associated with obtaining a succession certificate or executor fees in case of property transfer through inheritance.
Litigation expenses for claiming enhanced compensation in case of compulsory acquisition.
It’s important to remember that these expenses are deductible only for the purpose of calculating Capital Gains and cannot be claimed as deductions from any other heads of income. Additionally, the cost of acquisition and cost of improvement can also be deducted from the sales consideration.
Taxation on Long-term and Short-term Gains
Type of Capital Gain
Tax Rate
Long Term Capital Gain under Section 112 (when Securities Transaction Tax is not applicable)
20% + Surcharge and Education Cess
Long Term Capital Gain under Section 112A (when Securities Transaction Tax is applicable)
10% over and above INR 1 lakh
Short Term Capital Gain (when Securities Transaction Tax is not applicable)
Normal slab rate applicable to Individuals
Short Term Capital Gain under Section 111A (when Securities Transaction Tax is applicable)
15% + Surcharge and Education Cess
The taxability of gains from the sale of Equity and Debt mutual funds are different. Funds with more than 65% of the portfolio consisting of equities are called Equity Funds.
Short Term Capital Gain
Long Term Capital Gain
Debt Funds
Normal slab rate applicable to Individuals
20% with Indexation + Surcharge and Education Cess
Equity Funds
15% + Surcharge and Education cess
Exempt
Note: Unlike Equity mutual funds, debt funds have to be held for more than 36 months to qualify as Long Term Capital Assets.
Capital Gain Exemption
Indeed, the Income Tax Act provides avenues for total or partial exemption from Capital Gains tax under various sections. Taxpayers can benefit from multiple Capital Gains exemptions offered by these sections simultaneously. However, it’s crucial to note that the total amount of exemption claimed cannot surpass the total Capital Gain amount.
These exemptions serve as valuable tools for taxpayers to reduce their tax liabilities and optimize their financial planning strategies. By leveraging these provisions effectively, taxpayers can maximize their tax savings while ensuring compliance with the relevant tax regulations.
Residential house or residential plot of land (LTCA)
Subscription in equity shares of eligible startup
Individual/HUF
Gathering the necessary documents is crucial when dealing with Capital Gains and filing your tax returns. Here’s a rundown of the essential documents you’ll need:
PAN (Permanent Account Number): This alphanumeric ID, issued by the Income Tax Department, links all your financial transactions with your income. It’s essential for tax compliance and filing your Income Tax Return (ITR).
Aadhaar Card: The 12-digit unique identification number issued by UIDAI is mandatory for Resident Individuals when filing their ITR. It’s another crucial document for tax purposes.
Details for Capital Gains Calculation and ITR-2 Filing:
Purchase Date
Sale Date
Period of Holding the Asset
Transaction or Brokerage Charges (if applicable)
Form 16: Salaried individuals who have had TDS deducted from their salary receive Form 16 from their employer. It provides a detailed statement of the salary earned during the Financial Year, along with deductions, exemptions, and taxes deducted at source.
Form 26AS: This is a consolidated Tax Credit Statement that provides various details to taxpayers, including:
Taxes deducted from the taxpayer’s income
Taxes collected from the taxpayer’s payments
Advance Tax, Self-Assessment Tax, and Regular Assessment Taxes paid by the taxpayer
Details of refunds received during the year
Details of high-value transactions, such as shares and mutual funds
Investment Proofs: Certain investments and expenses are eligible for deductions under Chapter VI-A of the Income Tax Act. You’ll need investment proofs to claim these deductions, which can help reduce your taxable income.
Gathering and organizing these documents ensures smooth and accurate tax filing, helping you comply with tax regulations and potentially reduce your tax liability through eligible deductions.
Important Keyword: Capital Gains, ESOP, Form 16, Salary Income.
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Taxation on ESOPs
Employee Stock Ownership/Option Plans (ESOPs) stand as a strategic approach for companies aiming to foster a deeper sense of engagement and commitment among their employees. These initiatives operate by granting employees a direct stake in the company, often in the form of shares. By doing so, ESOPs cultivate a vibrant workplace culture where every team member feels personally invested in the company’s success.
This approach not only offers employees tangible financial rewards but also cultivates a shared sense of purpose and unity. With each staff member motivated by a common goal of advancing the company’s interests, ESOPs can serve as a powerful driver of employee satisfaction and organizational growth.
What are ESOPs?
ESOPs, or Employee Stock Ownership Plans, represent a valuable employee benefit program offered by companies to their workforce. These plans enable employees to acquire company stock at a price lower than the prevailing market rate, thereby providing them with an opportunity to become shareholders in the organization. ESOPs can take various forms, including direct stock issuance, profit-sharing schemes, or bonuses.
The process of issuing ESOPs typically involves several steps:
Decision by the Company: The company or employer decides to issue ESOPs as part of its employee compensation strategy.
Employee Exercise: Employees who are eligible for ESOPs have the option to exercise them, which involves purchasing the allocated shares at the predetermined price.
Share Sale: Following the exercise of ESOPs, employees may choose to sell the acquired shares at a later date, potentially realizing a profit if the stock price has appreciated.
Before implementing an ESOP program, employers must adhere to the rules and regulations outlined in the Companies Act of 2013. These regulations govern the issuance, administration, and reporting requirements associated with ESOPs, ensuring transparency and fairness in their implementation.
ESOP Terms
Meaning
Grant Date
The date on which the employer and employee agree to provide the employee with the option to acquire shares of the company.
Vesting Date
Date on which the employee is entitled to buy shares.
Vesting Period
The period between the grant date and the vesting date.
Exercise Period
The duration during which an employee may purchase vested shares.
Exercise Date
The Date on which the employee exercises the stock option.
Exercise Price
The Price at which the employee exercises the stock option.
Tax Implications of ESOPs
SOPs entail taxation at two significant junctures:
At the Time of Purchase/Exercising: When an employee exercises their stock option by agreeing to purchase the shares, it is regarded as a perquisite under the salary income category. The taxable amount is determined by the disparity between the Fair Market Value (FMV) on the exercise date and the exercise price.
This perquisite is taxed in the fiscal year when the employee exercises the ESOP.
The employer is responsible for deducting Tax Deducted at Source (TDS) on this amount and providing Form 16 to the employee.
It is incumbent upon the employee to report this income as Salary Income in their Income Tax Return (ITR), claim TDS Credit, and pay tax on such income at the applicable slab rates.
Example
Neha, an employee at Zomato, exercised her ESOP options during the financial year 2023-24. She chose to purchase shares of the company on 07/07/2023, acquiring a total of 2000 shares at a price of INR 120 per share. The Fair Market Value (FMV) of these shares at the time of exercise was INR 165 per share. Let’s delve into the tax implications of this transaction:
In this scenario, the company will treat the INR 3,30,000 as taxable salary and deduct TDS accordingly. When filing her Income Tax Return (ITR), Neha must report the INR 3,30,000 as Perquisites under the head “Income from Salaries”.
Budget 2020 Amendment
In the Budget 2020 announcement, the finance minister introduced a significant change regarding the taxation of shares allotted to employees by startups under Employee Stock Ownership Plans (ESOPs). Starting from the financial year 2020-21, employees receiving ESOPs from eligible startups no longer need to pay tax in the year of exercising the option. Instead, the deduction of Tax Deducted at Source (TDS) on the perquisite amount can be deferred by the employer until one of the following events occurs, whichever is earlier:
Expiry of 5 years from the year of ESOP allotment
Date of sale of ESOP by the employee
Date of termination of employment
At the time of sale or transfer of shares
When an employee sells the shares, it is treated as Capital Gains. Here’s the tax treatment for the sale of shares under ESOP:
Capital Gain is calculated as the difference between the Sale Price and the Fair Market Value (FMV) as on the exercise date.
The period of holding is calculated from the exercise date to the date of sale.
Capital Gains are taxed in the financial year in which the employee sells the shares.
The employee must report Capital Gains in their Income Tax Return (ITR) and pay tax on such income at the applicable rates.
Furthermore, in the case of ESOPs from a foreign company, the tax treatment is similar to that of domestic securities. However, it is obligatory for employees to disclose their holdings under Schedule Foreign Assets (FA) while filing their ITR.
Type of Share
Period of Holding
Capital Gain
Tax Rate
Listed Shares
<= 12 months
STCG u/s 111A
15%
> 12 months
LTCG u/s 112A
10% in excess of INR 1 lakh
Unlisted Shares
<= 24 months
STCG
slab rates
> 24 months
LTCG u/s 112
20% with Indexation
Example
In the given scenario, Neha sold her ESOPs on 20/01/2024, after exercising them on 07/07/2023, with an FMV of INR 165 per share on the exercise date and a sales price of INR 225 per share.
Here’s how the tax treatment and calculation of tax liability unfold:
Period of Holding: 07/07/2023 to 20/01/2024 (less than 12 months)
Type of Capital Gain: Since the shares are from a company listed on a recognized stock exchange in India and the holding period is less than 12 months, it qualifies as a Short-Term Capital Gain.
Tax Rate: The applicable tax rate is 15% under Section 111A.
Capital Gain per share: Sales Price – FMV = 225 – 165 = INR 60 per share
Total Capital Gains: 2000 shares * INR 60 per share = INR 1,20,000
Tax Liability: INR 1,20,000 * 15% = INR 18,000
Thus, Neha’s tax liability on the Short-Term Capital Gains from the sale of her ESOPs amounts to INR 18,000 for the financial year 2023-24.
How to calculate FMV for ESOPs?
Type of Share
Meaning
Trading Status
Fair Market Value (FMV)
Listed Shares
Listed on a recognized stock exchange in India
Traded on a recognized stock exchange as on the exercise date
Average of opening and closing price
Listed Share
Listed on a recognized stock exchange in India
Not traded on a recognized stock exchange as of exercise date
Closing price on the date preceding the exercise date
Unlisted Share
Not listed on a recognized stock exchange in India
NA
Price determined by a merchant banker
Treatment of Loss from Sale of ESOPs
When it comes to losses incurred from the sale of shares obtained through ESOPs, they are treated as Capital Losses. Here’s how the taxation and treatment of such losses unfold:
Loss on the sale of listed shares held for over 12 months or unlisted shares held for over 24 months qualifies as a Long-Term Capital Loss.
Long-Term Capital Loss (LTCL) can be set off against Long-Term Capital Gain (LTCG) exclusively. Any remaining loss can be carried forward for up to 8 years and set off against LTCG only.
Loss on the sale of listed shares held for up to 12 months or unlisted shares held for up to 24 months is termed a Short-Term Capital Loss.
Short-Term Capital Loss (STCL) can be set off against both Short-Term Capital Gain (STCG) and Long-Term Capital Gain (LTCG). Any remaining loss can be carried forward for up to 8 years and set off against both STCG and LTCG.
