5-year relaxation on ESOP tax: Budget fulfils long-standing demand from start-ups

Recognising start-ups as engines of economic growth, Finance Minister Nirmala Sitharaman has agreed to a long-standing demand from industry to tax employees only at the realisation of ESOPs (employee stock options).

She has done this by deferring the tax payment on ESOPs by five years, or till the employees holding ESOPs leave the company or when they sell their shares, whichever is the earliest.

The move is significant as ESOPs are the trump card for start-ups to attract and retain top talent for a longer period and constitute a significant component of compensation for these employees. At present, ESOPs are taxable as perquisites at the time of exercise, which leads to cash-flow problems for employees who do not sell the shares immediately and continue to hold the same for the long term.

“The proposed deferred payment of five years in tax liability will ensure people get what they deserve and also encash at the first potential opportunity. This would excite them to be part of start-ups and increase the importance of ESOPs. This would also encourage more employees to participate in the programme. Moreover, this would also help more liquidity in the market as transactions would take place. A win-win for start-ups and its team,” said Pravin Agarwala, co-founder and CEO, Betterplace.

“From a start-up and innovation standpoint, deferment of taxes on ESOP for employees is great news. I only wish it was deferred till the time of selling rather than requiring the employee to pay tax at the end of five years or at time of quitting the company, as they may not have the liquidity to pay tax,” said Kunal Upadhyay, Managing Partner of Bharat Innovation Fund.

He added, “Also, the focus on quantum computing, local data centres and recent announcement of making public datasets available should together give a boost to India’s AI and deep-tech aspirations.”

Union Budget 2020 provided another shot in the arm for start-ups, in the form of an increase in turnover over limit to ₹100 crore from the existing ₹25 crore and the number of years to 10 years from the existing seven years, to claim deduction of 100 per cent of its profits for three consecutive years.

“This is a positive step, as it will boost the cash-flow situation for early-stage start-ups who sometimes fail before they take off because of the liquidity crunch. Also, by exempting companies with turnover up to ₹5 crore from audit, it reduces the compliance burden on them,” said Anil Joshi, Managing Partner, Unicorn India Ventures.

“The government has also proposed a policy on early-life and seed-stage funding for start-ups to validate their business idea and run PoCs (proof of concept); we believe this would help grassroots development and will encourage more university-led IPs, which is a good boost for innovators,” Joshi said.

He added: “However, the fineprint will tell us what kind of financial support early-stage start-ups will get in the coming months. We hope the procedure to avail these services is less complicated.”

While overall the Budget was positive for start-ups, the parity on listed and unlisted securities tax exemptions has not been addressed. “When economic growth and employment creation are big themes of the Budget, then this issue should have been addressed. Why should investments in listed securities attract lower taxes than investments in unlisted start-ups, which generate employment and contribute to economic growth?” said K Ganesh, serial entrepreneur, Partner at GrowthStory.in.

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