Employee stock option plans (ESOP) is a popular incentive scheme employers offer, particularly multinational corporations to hire and retain their employees. Employees who participate in an ESOP have the option to share equity ownership in the business and benefit from the company’s growth. “Part of Indian employees’ compensation package may include being granted stock options by foreign firms like Microsoft. These grants allow the workers to buy shares at a predetermined price over a period agreed on contractually,” says Viram Shah, CEO of Vested Finance.
Stock options are provided to qualifying employees under an ESOP, and they can be exercised in the future to acquire equity shares of the company at a predetermined exercise price. Grant letters are provided to qualifying employees and include the Grant date, vesting details, exercise price, and other conditions. The vesting period starts from the day the option is granted to the date the employee becomes eligible to exercise it. “While still under vesting, this means that there is a period that workers must wait before they can use their options. After these options have been vested, then employees may exercise them and purchase stocks at the pre-determined exercise price which is usually less than the current market value,” adds Shah.
After the vesting period, employees can exercise options, which are then allotted to them by the company, converting them into company shares. “Once they’ve done this, some may prefer to hold on to the shares to take advantage of potential value increases before selling them off again. The sale of such securities often happens through the foreign stock exchange where the firm’s name has been registered like NASDAQ in the case of Microsoft,” says Shah.
Given the many processes required in implementing an ESOP (i.e. grant, vesting, and exercise), it is critical to understand the applicable tax regulations to evaluate taxability for employees. According to the rules of the Income Tax Act of 1961 (the Act), tax implications arise at two stages: when options are exercised and when shares are sold.
How are ESOPs given to Indian employees taxed? Viram Shah, CEO of Vested Finance explains in brief.
When an employee exercises ESOPs in India, the differential between the fair market value (FMV) of shares on the exercise date and the exercise price is regarded as a perk added to the employee’s salary for tax purposes.
Upon selling the shares, capital gains tax applies, with the nature of the gain depending on whether it is short-term or long-term, which depends on how long after an option is held. Short-term capital gains (STCG) are taxed at slab rates if one holds for less than 24 months.
Long-term capital gains (LTCG) is taxed at 20% with indexation if shares have been held for more than 24 months. Besides, employees can also take advantage of the Double Taxation Avoidance Agreement (DTAA), which exists between India and countries like the USA where his company is located to avoid double taxation.