ESOPs and RSUs have become common in India with jobs gaining popularity. Several international companies with employees in India also offer ESOPs.
ESOP (Employee stock option plan) or RSU (Restricted Stock Units) is an employee benefit plan offering employees an ownership interest in the organisation in the form of equity shares. It is similar to a profit-sharing plan. Under these plans, the company, which is an employer, offers its stocks at negligible or low prices. These stocks remain in an ESOP trust fund till the vesting period and exercise these options or retire/leave the company.
Let’s understand how ESOPs are taxed.
Before you understand the taxation of ESOPs and RSUs, here are some key terms you must know:
ESOPs are taxed in 2 instances –
Capital Gain computation is as follows:
Particular | Amount |
Sale Value | XXXXX |
Less : Cost of acquisition (FMV as on date of exercise)
| XXXXX |
Capital Gain | XXXXX |
At the time of | Units | Date | Exercise Price | FMV of share* | Tax impact | Rate of tax | Tax to be paid | In income tax return |
Grant | 100 | 1-Apr-12 | 100 | 120 | nil | nil | nil |
|
Vesting | 100 | 1-Apr-14 | 100 | 150 | nil | nil | nil |
|
Exercise | 100 | 1-Jul-14 | 100 | 170 | Taxable amount = FMV on Exercise date (1st July 2014) less Exercise Price | Income tax slab rate | Tax = 30% x 100 shares x (Rs 170 - Rs 100) = Rs 2100 and 3% cess on it | Under Income from Salary |
Sale of shares if listed | 20 | 1-Oct-14 |
| 250 | Taxable amount = Sale Price on date of sale less FMV on exercise date | 15% on short term capital gains | Tax =15% x 20 shares x (Rs250 - Rs170)= 240 and 3% cess on it | Under Capital Gains (short term capital gains) |
Sale of shares if listed | 80 | 1-Sep-16 |
| 300 | nil, long term capital gains on listed shares is exempt from tax | long term capital gains are exempt | nil, long term capital gains on listed shares is exempt from tax | Exempt Income |
Sale of shares if unlisted | 20 | 1-Oct-14 |
| 250 | Taxable amount = Sale Price on date of sale less FMV on exercise date | Income tax slab rate | Tax =30% x 20 shares x (Rs250 - Rs170)= 480 and 3% cess on it | Under Capital Gains (short term capital gains) |
Sale of shares if unlisted | 80 | 1-Sep-16 |
| 300 | Taxable amount = Sale Price on date of sale less FMV on exercise date | 20% tax on long term capital gains after indexation of cost | Tax = 20% x 80 shares x (Rs 300-Rs 170*CII for 2016-17/CII for 2014-15) = 20% x 80 x (300 - 170*1125/1024) = Rs 1811 and 3% cess on it | Under Capital Gains (long term capital gains) |
Fair Market Value (FMV) of a stock is the Fair value or the market price of such stock at the time of exercise. This becomes relevant since when such Stock options are sold, FMV at the time of exercise will be considered for the cost of acquisition.
Advance Tax rules require that your tax dues (estimated for the whole year) must be paid in advance. Advance tax is paid in instalments. While the employer deducts TDS when you exercise your options, you may have to deposit advance tax if you have earned capital gains on subsequent sales.
For FY 2023-24 for individuals instalments are due on 15th June, 15th September, 15th December, and 15th March. By 15th March, 100% of your taxes must be paid.
Non-payment or delayed payment of advance tax results in penal interest under sections 234B and 234C. However, it may be hard to estimate tax on capital gains and deposit advance tax in the first few installments if a sale takes place later in the year.
Therefore when advance tax instalments are being paid, no penal interest is charged where the installment is short due to capital gains. The remaining installment (after the sale of shares) of advance tax, whenever due, must include a tax on capital gains.
To properly calculate tax on the sale of ESOPs certain other aspects need to be considered as well.
Sell to Cover the transaction
When the stocks are exercised after vesting is complete, the employer is liable to deduct TDS u/s 192 on the fair market value of such exercised option. FMV of such stocks are considered as Perquisite and is taxable under the head Income from Salary.
Now the question is, since this is non-monetary compensation (in the form of stocks), how will the employer deduct and pay the TDS? Employers can either ask you to pay the TDS on such allowed stocks via Bank transfer to the company account or, in the majority of cases Employer will do a sell-to-cover transaction. It involves selling a part of the shares from the allotted stocks to cover the taxes.
An example for sell to cover transaction for stock listed in the US Exchange is given below
Transaction in your Demat
RSU Vested | 100 |
Market Value (Per Share) at vest | $60 |
Total Gain (Taxable Income) | 100* $60 = $6,000 |
Tax withholding requirement | $6,000*31.2% = $1,872 |
Average Sale price (per share) for sale to cover | $58 |
Shares Sold to cover withholding | $1,872/$58 = 33 |
Cash Value of shares sold for withholding | 33*$58 = $1,914 |
Net shares deposited to your Demat | 100-33 = 67 |
Since in the above transaction, stocks are being sold, this might give rise to notional capital gain or loss which is necessary to be declared in your Income tax return.
Tax Computation in your Payroll by your employer
US$ to Local currency Exchange rate | 74.10 |
Perquisite Income (Income from Salary) | $6,000*74.10 = 444,600 |
Withholding cash received by the employer | $1,914*74.10 = 141,828 |
Actual Tax Withholding liability (TDS) | Rs. 139,610 |
Over-withholding cash refunded | 141,828-139,610 = Rs. 2,218 |
It is important to note that the above calculation is for your information only, the necessary calculation will be done by your employer, and the data will be reflected in your Form 16, and no action is required here. As an employee, attention is required only when you subsequently sell such shares in the market where capital gains will be attracted.
Capital Gain Impact on Subsequent Sale - Short-term or long-term gains
The rates at which your capital gains shall be taxed depend on the period of holding them. The period of holding is calculated from the exercise date up to the date of sale. Equity shares listed on a recognized stock exchange (where STT is paid on sale) are considered long-term gains when held for more than one year. If sold within one year, they are considered as short-term gains. Currently, long-term gains on listed equity shares are taxed at 10% without indexation on LTCG above Rs 1 lakh, whereas short-term capital gains are taxed at 15%.
When you have incurred a loss
In case you have incurred a loss, you are allowed to carry forward the short-term capital losses in your tax return and adjust & set them off against gains in future years.
Listed or unlisted shares
The Income Tax Act differentiates between tax treatment of listed and unlisted shares. The tax treatment for shares that are unlisted in India or listed out of India remains the same, i.e. if you own shares of an American company, they will not be listed in India.
They may be considered unlisted for the purpose of taxes in India. The shares are short-term when held for less than 3 years and long-term when sold after 3 years. Starting FY 2016-17, Unlisted Equity Shares shall be short-term capital assets – when sold within 24 months of holding them and long-term capital assets – when sold after 24 months of holding them [Applicable for sales made on or after 1st April 2016].
The period of holding begins from the exercise date up to the date of sale. In this case, short-term gains are taxed at income-tax slab rates, and long-term gains are taxed at 20% after indexation of cost.
Summary of Tax implication on the sale of stocks as follows
Particular | Holding Period | Short-Term Tax Rate | Long-Term Tax Rate |
Indian Listed Company | 1 year | 15% | 10% (Up to 1 lakhs exempt) |
Indian Unlisted Company | 2 year | Slab rates | 20% with indexation |
Foreign Listed Company | 2 year | Slab rates | 20% with indexation |
Foreign Unlisted Company | 2 year | Slab rates | 20% with indexation |
Buyback of Stock Options
Buyback of stock options involves where the company decides to buy back the option before exercise of such option into equity shares. This is quite common in Indian Unlisted companies/startups. Indian startup incentivises its employees by giving ESOP but, as a condition, allows conversion into equity only on liquidation event (like IPO, Further investment rounds). Since the shares are not liquid due to an inactive market employer might decide to buy back the options even before such options are exercised to provide liquidity to its employees.
Employers consider such buyback as Income under the head ‘Salary’ and deduct TDS u/s 192. Thus it will be reflected in your Form 16, and it need not be separately disclosed in your ITR.
Residential status
Your income is taxable in India according to your residential status. If you are a resident, all your income from anywhere in the world is taxed in India. On the other hand, if you are a non-resident or resident but not ordinarily resident and have exercised your options or sold your shares outside India, you are not liable to pay tax in India. Thus determination of Residential status becomes crucial.
Disclosures
Several disclosures have been added to income tax return forms for foreign assets. If you own ESOPs or RSUs of a foreign company, you may have to disclose your foreign holdings under schedule FA of your income tax return. These disclosure requirements are applicable to a resident taxpayer.
When options are not exercised
On the vesting date, the employee gains a right to exercise his option or buy the stocks. But there is no obligation, the employee can choose not to exercise his option. In such a case there shall be no tax implication for the employee.
Tax deductibility of ESOP expenses