RSU vs ESOP Taxation: What Are the Differences and Which One Is Better?

Employers often grant different benefits to their employees throughout employment to keep them motivated and attract new talent. These benefits can sometimes come in the form of company shares as well. Such shares are granted either in the form of RSU or ESOP. As a salaried employee, it is crucial to understand these employment perks to make the most out of them.

In this article, we have covered what each means and a detailed comparison to help you choose between them.

What is ESOP?

Employee Stock Option Plan or Employee Stock Ownership Plan (ESOP) is a company's way of rewarding its employees. It gives an employee the right to buy company shares on a future date at a predetermined price. 

Once an employer grants ESOP, they do not immediately transfer it to that employee. They instead transfer the shares to a trust, and it remains there for a certain time, known as the vesting period. At the expiry of the vesting period, also known as the vesting date, the employee can choose to exercise his/her right to buy the shares.

Example of ESOP 

Let's say a company S Ltd. offered 200 shares of their company to its employee Mahesh on 20th April 2020. The vesting period was of 3 years, and Mahesh could choose to exercise this right on 21st April 2023. 

Now if on 21st April 2023, the company's shares are trading at a price higher than 200, Mahesh can exercise his right to purchase those shares. However, it won't make any sense if they are trading at a lower price. In this case, he can choose to surrender his right to the ESOP.

What is RSU?

Restricted Stock Units (RSUs) are another form of incentive an employer can grant to his employees. It is a promise by an employer granting employees a predetermined number of shares free of cost at the end of the vesting period, provided certain conditions are met.

Even though employers grant RSUs free of cost, it comes with certain restrictions.

• Time-based restrictions: With these RSUs, an employee can sell them only after completing a specified period of employment with their employer. If they resign during the vesting period, their employer can revoke the RSU.
• Milestone-based restrictions: It is a performance-based restriction where the employer can only exercise their ownership of the shares after achieving a predetermined milestone. 
• Composite restrictions: This is a composition of both time-based and mile-based restrictions. An employee must complete a specified period and achieve a determined milestone to get ownership of these shares.

Example of RSU

A company, P Ltd., has promised to grant its employee Ramesh 3,000 units of their shares as RSU. It is restricted by time, and they will start vesting these shares to him after the completion of 2 years. From the 3rd year onwards, he will receive 1,000 shares every year. 

This arrangement to vest 1,000 shares every year is called a vesting schedule. If Ramesh quits this organisation before the vesting period ends, he won't receive any shares.

Differences between ESOP and RSU

Here are the main differences between RSUs vs ESOPs:

RSU vs ESOP Taxation

Both RSUs and ESOPs are taxable as perquisites at the time when employees receive the share. For ESOPs, it is taxed when employees exercise the options, while RSUs are taxed when received.

An employee has to pay TDS on the shares when he/she receives them. The value of perquisite is determined by the fair market value reduced by the price paid to get the shares. So in the case of RSU, the fair market value will be the value of perquisites as the employee receives them free of cost.

However, when the shares are sold, they are taxable as per capital gains taxation rules. Both RSUs and ESOPs have the same treatment for capital gains.