LTCG vs ESOP: Taxing employees’ productiveness

Updated: March 28, 2018 2:13 PM

The shares sold pursuant to the exercise of ESOPs should have been given an exemption from tax on LTCG

LTCG, ESOP, Union Budget 2018The Union Budget 2018 has impacted only the long-term capital gains, and the short-term capital gains were left untouched.

On February 1, 2018, history was rewritten and what was scrapped in 2004-05 was brought back in a new avatar. The Union Budget 2018 assured that it will be primarily remembered for one and only thing, i.e. LTCG, or long-term capital gains tax. This year’s Union Budget has finally ushered back in the LTCG era and this change can really impact your investments in multiple ways. The rationale given for such introduction in the memorandum is that the existing tax regime is biased towards manufacturing, which has led to diversion of investments in financial assets. The introduction of capital gains tax would provide a level-playing field.

Now, it is sought to tax long-term capital gains arising on the sale of listed equity shares, units of equity-oriented fund or units of business trust at a rate of 10% (plus applicable surcharge and cess). Additionally, the said tax rate would apply to the following:
*To the listed equity shares, where both the acquisition and sale have been subjected to the Securities Transaction Tax, or STT.

*  To the units of equity-oriented funds and the units of business trusts, where the transfer of such assets was subjected to STT.

Hence, with this, the employee stock option, which is given by a company to its employees as a reward for hard work and dedication, among other things, will also fall under the ambit of the new taxation norms. Suppose Mr A has 1,00,000 shares allotted pursuant to an employee stock option scheme at a cost of Rs 65 per share. Now, if Mr A sells those shares at, say, Rs 85 each after a period of two years, the taxability effect pre- and post-Budget would be poles apart.

For example, in the pre-Budget era, the total long-term capital gains would have arrived to Rs 25,00,000—Rs 85 (-) Rs 60 (x) 1,00,000—however, the tax on long-term capital gains was exempted if the STT was paid at the time of acquisition and sale of equity shares.

On the other hand, in the post-Budget era, the tax on long-term capital gains would amount to 10% of Rs 25,00,000 (-) Rs 1,00,000, i.e. Rs 24,00,000. The payable long-term capital gains tax would amount to Rs 2,40,000 as compared to nil in pre-Budget era.

Here it must be noted that in case the STT is not paid, then the long-term capital gains will be levied at the rate of 20% (with indexation) or 10% (without indexation), in both the pre- and post-Budget times.

The Union Budget 2018 has impacted only the long-term capital gains, and the short-term capital gains were left untouched. Further, the LTCG amendment has only impacted the listed entity, and the tax implications in case of unlisted entity were left untouched.
A 10% capital gains tax, while not significantly decreasing the attractiveness of investment in the financial sector, will surely affect the purpose for which employee stock options are given. The wealth creation tool will lose its effectiveness and only 90% of what was offered to an employee in return of her sweat and hard work will reach its owner.

The Rs 1 lakh exemption may not prove fruitful to the employees, as the current scenario indicates that the company is giving employee stock option benefits worth much more than what the exemption limit states. With no investment aim, an employee is still liable to pay 10% of the profits, which she has gained in return of giving her sweat and soul to the company. The shares sold pursuant to the exercise of employee stock options should have been given an exemption from tax on LTCG. As the present scenario is still shaky, time will tell what the future holds for employees.

By Ms. Mohini

AVP & Head, Esop Services, Corporate Professionals

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