Budget 2020: How ESOP tax changes will benefit start-up employees

Updated: Feb 10, 2020 12:32 PM

Budget 2020: Given the cash crunch, ESOPs are often used by start-ups to employ and retain highly-talented employees. This way they are able to reward employees without taking a hit on the cash flow.

budget 2020, budget 2020 proposals, ESOP, ESOP for start-ups, Employee Stock Option Plans, income tax benefit Budget 2020: The Finance Bill has sought to provide relief to employees of eligible start-ups by deferring the taxation to future years.

Budget 2020: The Honorable Finance Minister, during the Budget speech, mentioned that India has been a land of entrepreneurs since ancient times. This entrepreneurial spirit has grown significantly in recent years as can be witnessed by an increasing number of start-ups operating in the economy.

Start-up Dynamics

Start-ups typically have a great business idea but limited financial resources to operate in the initial years. At the same time, these are critical years which decide the fate of the start-up and, therefore, necessitate that the best talent is recruited and retained. Given the cash crunch, Employee Stock Option Plans (ESOPs) are often used by start-ups to employ and retain highly-talented employees. This way they are able to reward employees without taking a hit on the cash flow.

From an employee perspective, this gives them an opportunity to participate in the success of the start-up. However, the challenge is with the taxation on deemed benefit versus realised benefit. As per present tax laws, ESOP is taxable as a perquisite on exercise at the time of allotment. It means that the employee has to pay tax once the shares are allotted even if there is no liquidity event. Given that the shares of start-ups are generally unlisted, there is no available market to sell them and generate cash. This creates a cash flow challenge for employees as they receive a benefit in kind but need to pay tax from their pocket.

Budget 2020 Proposal

Considering the above challenge, the Finance Bill has sought to provide relief to employees of eligible start-ups by deferring the taxation to future years. It is proposed that the stock option allotted by an eligible start-up shall be taxable at the earlier of following events –

# expiry of 4 years from the end of the year in which shares are allotted; or
# sale of stock option by the employee
# resignation by the employee

The employer will need to deduct and remit taxes within fourteen days of the happening of any of the aforesaid events. While the taxable event will be deferred, the taxes will have to be computed at the tax rate applicable for the employee in the year of allotment. The intent is to ensure that there is no benefit or disadvantage to the employee on account of change in tax rates.

It is imperative that the employer has a mechanism in place to keep tab on the trigger events mentioned above and ensure requisite tax compliance to avoid interest and penalty.

There are changes proposed in section 140A to enable the employee to pay tax on the benefit in case the employer does not comply.

This is certainly a welcome move as it gives much-needed relief to employees who were laden with tax burden on such benefit. The Finance Minister should extend this benefit to stock awards of all unlisted companies.

(By Aarti Raote, Partner, Deloitte India; with Arvind Vyas, Senior Manager, and Kavitha K, Deputy Manager, Deloitte Haskins and Sells LLP)

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