Important Keyword: Capital Gains, ESOP, Form 16, Salary Income.
Table of Contents
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. |
Dual Taxation Framework
ESOPs incur taxes at two stages:
A. At Exercise (Perquisite in Salary Income)
- Taxable perquisite = Fair Market Value (FMV) on exercise date − Exercise price.
- For listed shares, FMV is the average of the opening and closing price on the exchange; for unlisted, it’s based on a merchant banker’s valuation per Rule 3(8).
- This amount is taxed as salary and subject to TDS by the employer.
B. At Sale (Capital Gain Tax)
- Cost base = FMV at exercise.
- Short-term vs Long-term:
- Listed shares: ≤12 months → STCG @ 15% (raised to 20% for FY 2024‑25), >12 months → LTCG @ 12.5% (10% earlier) on gains exceeding ₹125,000.
- Unlisted shares: ≤24 months → slab rates, >24 months → LTCG @ 12.5% without indexation.
ESOP Tax Relief for Startups
Introduced by Finance Act 2020, employees of eligible DPIIT/startups (incorporated Apr 2016–Mar 2021, turnover ≤₹100 Cr) can defer perquisite tax. The TDS is deferred until the earliest of:
- 5 years from allotment
- Sale of shares
- Employment termination
Current Scope: Applies to just ~3,600 IMB-certified startups—about 2.5% of DPIIT‑registered companies . Experts are urging expansion to all DPIIT-registered firms
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:
- Purchase Price: INR 120
- FMV: INR 165
- Perquisite: INR 45 (FMV – Purchase Price)
- Taxable Perquisite Amount: INR 3,30,000 (2000 shares * INR 165)
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 above 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.
Compliance Essentials & Practical Tips
| Requirement | Details |
|---|---|
| Employer TDS | Mandatory on salary; deferred only if startup-eligible |
| Capital Gain Treatment | Comply with STCG/LTCG rules; pay advance tax if needed. |
| ITR Disclosure | Include ESOP exercise in Form 16; sale in capital gains; overseas assets in Schedule FA |
| Advance Tax | Apply for gain from sale if not covered under salary |
Frequently asked Questions
1. When exactly do I need to pay tax on ESOPs?
Answer: Tax on ESOPs is triggered at two points: first, when you exercise the option to buy shares—this is treated as part of your salary; and second, when you eventually sell those shares—this is taxed as capital gains. So, you may have to deal with two separate tax events in different financial years.
2. How is the tax calculated when I exercise my ESOPs?
Answer: When you exercise your ESOPs, the difference between the market value of the share on that day and the price you paid is considered a taxable perk. This amount is added to your salary and taxed as regular income, meaning your employer will deduct TDS on it just like with any other component of your salary.
3. Do I still have to pay tax when I sell the shares, even if I already paid it while exercising?
Answer: Yes, you do. The earlier tax covers the benefit of buying shares below market value, but once you sell those shares, the profit you make (if any) is taxed again as capital gains. The gain is the difference between your sale price and the fair market value on the day you exercised your ESOPs.
4. How long do I need to hold the shares to qualify for long-term capital gains tax?
Answer: If the shares are listed on a recognized stock exchange in India, you need to hold them for more than 12 months. If they are unlisted, the holding period must exceed 24 months. Holding them for less than these durations would attract short-term capital gains tax, which is typically higher.
5. What tax relief do startup employees get on ESOPs?
Answer: If you work for an eligible startup recognized by the government, you don’t have to pay tax right away when you exercise your ESOPs. Instead, the tax can be deferred for up to five years, or until you sell the shares or leave the company—whichever happens first. This can ease your cash flow burden significantly.
6. What happens if I sell my ESOP shares at a loss?
Answer: If you sell your shares for less than their fair market value at the time you exercised them, the loss is treated as a capital loss. Depending on how long you held the shares, it will be categorized as either short-term or long-term. These losses can be used to offset other capital gains, or carried forward for up to 8 years.
7. How do I report ESOPs in my income tax return?
Answer: The perquisite value from ESOPs will appear in your Form 16 under the salary section and must be reported accordingly. When you sell the shares, the profit or loss from the transaction should be declared under the capital gains schedule of your ITR. If the shares are from a foreign company, you also need to disclose them under the foreign asset reporting section.
8. What if I don’t sell my ESOP shares—do I still pay any tax?
Answer: Simply holding the shares doesn’t create a second tax event. You only pay tax at the time of exercising and then again if and when you decide to sell the shares. If you never sell them, no capital gains tax arises—but the initial perquisite tax at the time of exercise still applies.
Read More: Section 112A: Tax on Long Term Capital Gain on Shares
Web Stories: Section 112A: Tax on Long Term Capital Gain on Shares
Official Income Tax Return filing website: https://incometaxindia.gov.in/
