GST on ESOP: Applicability and Implications in India

Recently, certain ambiguities emerged regarding the implication of GST on Employee Stock Options. Is GST applicable to ESOPs? If yes, how is it applicable, and what is the extent of the GST implications on ESOPs?

The Central Board of Indirect Taxation (CBIC) has already clarified its position on this matter through an official circular. This article discusses the ambiguity surrounding the issue and the latest position of CBIC. Stay with us. 

What is an ESOP? 

Startups and growth-oriented companies often adopt various ingenious HR compensation techniques to attract talents and retain them for a longer duration. ESOP, ESPP, and RSU are popular among them. 

• ESOP - Employee Stock Option 
• ESPP - Employee Stock Purchase Plan 
• RSU - Restricted Stock Units 

These compensation techniques are similar in the sense that they attract talents and eligible employees with a commitment to allotting company shares to their names at a discounted price or at no costs. Such commitments come with a set of pre-specified terms and conditions.

One such condition is the Vesting Period. It indicates the minimum period of employment that an employee must complete before they can exercise their ESOP. Exercising an ESOP means the employee purchases the allotted shares from the company, paying the pre-specified price.

Once purchased, in compliance with the terms and conditions, an employee can hold the shares or sell them at the market valuation to realise the monetary gain. 

Example: 

Assume Mr. X joined Company ABC on January 1, 2019. During joining, the company offered ESOP of allotting 100 shares of ABC at a discounted price of Rs.100 per share with a vesting period of 5 years. 

The vesting period ends on January 1, 2024 and Mr. X is still employed with ABC. He exercises his option of purchasing 100 shares of ABC at a price of Rs.100 per share as per the previously offered Employee Stock Option plan. 

On February 1, 2024, Mr. X checked that ABC was trading at a price of Rs.200 per share on the stock exchange. He sold off the shares he purchased as per his ESOP. 

His total realised gain from ESOP was {(Rs.200 - Rs.100)*100 shares} or Rs.10,000. 

Let us assume, ABC trades at Rs.300 per share TODAY. If Mr. X had waited and sold his shares today, his gain ESOP would have been [(Rs.350 - Rs.100)*100 shares] or Rs.25,000.

It is important to remember that Mr. X must have paid STT, or Securities Transaction Tax, while selling his shares on the exchange. So, the actual gain will be a little less. 

Advantages of ESOP or similar compensation techniques 

• It saves startups and growth-phase companies from immediate cash outflows on employee compensation and improves employee retention. 
• ESOP becomes attractive only when a company’s valuation or share price increases. So, employees getting ESOP feel motivated to give their best performance toward achieving the company’s long-term business goals.
• Such compensation tools also offer potentially endless upper-side financial gains to employees.
• The vesting period of ESOP also improves the retention of talent in a growing company. 
• ESOP also offers tax advantages to employees.  

Process of ESOP Issuance 

The process for domestic companies issuing ESOPs to their Indian employees is simple. 

• The eligible employee completes the vesting period. 
• Informs the company to exercise the ESOP and makes the payments. 
• The company transfers the share to the employees’ demat account. 

However, the process for ESOP issuance is different for Indian subsidiaries of foreign multinational companies. ESOPs to employees of such subsidiaries make them eligible to get shares of the foreign holding company. 

• The eligible employee intimates the subsidiary to exercise their ESOP. 
• The subsidiary requests that the holding company transfer the share directly to the employee. 
• The holding company can also transfer the share to the subsidiary, which transfers the same to the employee. 
• In either case, the subsidiary reimburses the cost of the shares to the foreign holding company. 

GST implications for ESOP 

By definition, Employee Stock Option are part of employee-employer relations. It is a flexible part of the employee compensation package based on:

• Designation of an employee
• Vesting period as per the ESOP program 
• The company’s long-term business performance 

So, the Income Tax Act in India treats ESOP as a perquisite. Earlier, companies used to show the Fair Market Valuation (FMV) of the ESOP as income from salary in the Form 16 of the employee exercising the option. 

From FY 2020-21, the Income Tax Authority started treating earnings from ESOP as capital gains for eligible startups and technology companies. Depending on the date of exercise of the ESOP and the date on which the employee sells the shares, the capital gains can be treated as short-term or long-term gains.  

Is GST applicable to ESOPs? 

A GST applies to the sale of goods and services in India. But the GST Act does not recognise employee-employer relations as a taxable transaction of services. It is the reason GST does not apply to the payment of salary. And because ESOP is a variable part of employee remuneration, GST on ESOP is not applicable. 

• So, any domestic company allotting shares to its eligible employees as per the ESOP program does not need to pay GST. 
• As per the circular on 26th June, 2024, GST is not applicable if an Indian subsidiary of a foreign holding company allots shares of the holding company to the subsidiary’s employees as per an ESOP program. 
• The Indian subsidiary reimburses its foreign holding company for the cost of the shares it transferred at a Fair Market Value (FMV). Such transactions cannot be treated as the sale of goods and services. So, GST is not applicable to such payments.

However, it does not mean there are zero implications for GST on ESOPs. 

Applicability of GST on ESOPs

GST implications for ESOPs arise only when: 

1. Reimbursement of the cost of the shares to the holding company includes any additional fee, commission, or markup above the fair market valuation of the allotted shares. GST is applicable only to the additional amount beyond and above the FMV. 
2. The holding company can charge fees to process the transfer of shares to the subsidiary company for allotment, as per ESOP. GST applies to the fees charged.

Read more: What is ESOP? Full Form, Meaning, Taxation, Benefits & How Does It Work