Tax Treatment of Employee Stock Option Plans (ESOP)

An increasing number of multinational companies prefer granting Employee Stock Option Plans (ESOPs) to their employees wherein they are granted an option to buy the shares of the employer company at a discounted rate, lower than the market value

The taxation of ESOPs as per Indian laws is carried out in two stages. In the first stage, it is taxable in the hands of the employee as salary (prerequisite given by the employer), which is represented by the difference between the Fair Market Value (FMV) of the shares and the actual price at which they are purchased by the employees. The law lays down the procedure for determining the FMV of the shares.

The point of taxability is the date on which the option is exercised by the employee to subscribe to the shares. Employers are liable to deduct tax at source on this part of the income.

The second stage of taxability arises when the said shares are sold or transferred. The difference between the sale price and the FMV (calculated in the earlier phase of taxation) is taxable as capital gains. The tax treatment of such capital gains would be as prescribed in the section Capital Gains Tax in Chapter 7.

Furthermore, in the case of eligible start-ups, the tax on ESOP is to be paid within 14 days from the below mentioned events, whichever triggers at the earliest:

• After the expiry of a period of 48 months from the end of relevant assessment year in which they are issued
• From the date of sale
• From the date the assessee ceases to be an employee of the employer who allotted such shares or security