Personal Finance

Budget: How start-up employees gain from ESOP tax changes

Keerthi Sanagasetti | Updated on February 09, 2020

Tax on employee stock option plans can now be deferred by 48 months from applicable assessment year

In a bid to cajole employees, while also saving themselves from a dent on their cashflows, many employers resort to payments in kind. This has taken, in the modern days, the form of employee stock option plans (ESOPs), sweat equity shares or restricted stock units (RSUs), et al.

Despite these stock options not being a monetary gain, the Income Tax Act requires you to add all these to your taxable income, as you would do with your monetary inflows.

Hence, sweat equity shares, ESOP and RSUs are taxed at two instances. First at the time of allotment as a perquisite — forming a part of your income under salaries — and then subsequently at the time of their sale, under the head of capital gains.

The fair market value (FMV) of shares allotted under these schemes, less any amount paid by the employee, is taxable as perquisite, upon allotment.

Subsequently, on sale, tax on capital gains has to be paid on the difference between the sale price and the FMV.

For listed companies, the FMV shall be the average of the opening and closing prices on the date of exercising the options.

Let us consider an example. ‘X’ has exercised her ESOP on April 2, 2020. She was allotted 1,000 shares of ABC company on payment of ₹100 for each share.

On that day, the opening and closing prices of ABC’s shares were ₹101 and ₹105, respectively, — the average being ₹103.

At the time of allotment, ‘X’ will have to pay tax on ₹3,000 — the difference between ₹103 (FMV) and ₹100 (exercise price) multiplied by 1,000 shares.

For unlisted companies, the FMV of shares shall be determined by a merchant banker on the date of exercising the option.

The change

In a bid to promote the start-up culture, the I-T Act exempts certain income of eligible start-ups under Section 80 IAC. These are essentially companies or limited liability partnerships, incorporated between April 1, 2016, and April 1, 2021, that hold a certificate of eligible business from the Inter-Ministerial Board of Certification (IMB).

Also, these companies should have a turnover of less than ₹100 crore (amended in the Budget, from ₹25 crore earlier).

For employees of these start-ups, who are allotted shares under ESOP etc, such tax payable on the allotment of shares can be deferred by 48 months from the end of the relevant assessment year in which the shares are allotted.

This is thanks to the amendment proposed in the Budget.

However, if the employee quits the job or sells the shares before the expiry of the said 48 months, the perquisite shall be taxable in the year in which he/she quits or sells the shares.

Do remember that this is only a deferment of your tax liability. That is, whatever be the case, the perquisite will be taxed at the slab rate applicable in the year of allotment only.

In the above example, the tax shall be computed using the slab rates applicable in AY22 (Assessment Year) only, though the payment of the same can be deferred to AY26.

Not of much help

Given that employees are taxed immediately on exercising the ESOPs, they tend to sell the shares in the same year to meet the tax liability. For employees of start-ups that are not listed, the additional time will help in waiting for the stock to list, to get a good value.

Also the scope of applicability for the deferment is quite narrow.

The said deferment is available only to those start-ups (and their employees) who are eligible under Section 80 IAC.

Reportedly, of the 27,000 start-ups registered with the Department for Promotion of Industry and Internal Trade, the exemption under Section 80 IAC is availed by only about 250 odd companies.

Rakesh Nangia, Chairman, Nangia Andersen Consulting, explains: “If a start-up which has been approved by IMB breaches the condition of turnover of ₹100 crore, it will not be entitled to the deferment of taxes on ESOPs exercised in the year when such condition is breached and in the subsequent years.”

Nangia believes that similar relaxation should also have been made for ESOPs granted to employees of other companies, besides start-ups.

Published on February 09, 2020

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