EsoPs taxable as perk in hands of employee

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Published: April 28, 2015 1:26:12 AM

Esop benefits form a part of the employee’s salary income and are taxable as a perquisite.

BUSINESS houses often resort to innovative incentive policies to reward employees for their performance and, at the same time, boost their chances of long-term association with the company. One such incentive is employee stock option plan (Esop).

Equity incentives, or Esops, imply options/rights of an employee to purchase a certain number of shares in a company at a predetermined price. Such option/right is vested to the employee over a period of time and the price at which such an option/right can be exercised is lower than the prevailing market price of the share of the company.

The main aim of any Esop policy is to encourage an employee to become a stakeholder in the company, so that with the growth of the company, he/she grows as well. The vesting of the stock option happens over a period of the employee’s association with the company. Once this option vests with the employee, his/her decision to buy (or not) such shares has to be conveyed during the vesting period. When this option/right stands vested, the employee becomes entitled to exercising such an option over a prescribed period, which would allow subscribing to the shares under the Esop scheme at the exercise price, which is at a discount to the prevailing market price.

If Esops are exercised, the employee pays the exercise price and is allotted the shares. At that time, such an employee may sell the stock at a gain or hold on to it in hope of further price appreciation. Many companies (especially in the startup phase) have now started giving Esops as this is beneficial to both sides.

Esop benefits form a part of the employee’s salary income and are taxable as a perquisite. The perquisite value is computed as the excess of the fair-market value (FMV) of the share on the date of exercise over the exercise price. There are specific valuation rules prescribed for listed and unlisted companies to determine the FMV. The employer is required to withhold tax at source in respect of such a perquisite.

Additionally, in the event employee disposing of  the shares, the difference between the sale consideration of the shares and the FMV on the date of exercise is chargeable to tax under the head, capital gains, in the hands of the employee. The nature and rate of capital gains would depend upon the period of holding of shares from the allotment date. Further, the fact that whether security transaction tax (STT) has been paid on sale of such shares, is also a factor.

For listed shares where the STT is paid, there would be no tax if shares are held for more than one year, but the same is taxed at 15.45% if held for less than one year. For unlisted shares, the tax rate is 20.60% if held for more than three years; if the holding period is less than that, it is taxed at normal rates (based on the income slab).

The moot point, however, is whether we plan our investment in Esops keeping in mind the above considerations. Most of us sell the shares immediately upon receipt to enjoy the gains and regard this money as a bonus. But the tax implications need to be factored in before utilisation of such proceeds. As a planning tool, to optimise returns from Esops, hold them for a longer duration to characterise such gains as long-term gains.

The writer is partner, Nangia & Co

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