ESOPs and RSUs have become common in India with start jobs gaining popularity. Several international companies with employees in India also offer ESOPs.
Let’s understand how ESOPs are taxed.
Before we begin to understand taxation of ESOPs and RSUs, here are some key terms we must know
ESOP – or Employee Stock Option Plan allows an employee to own equity shares of the employer company over a certain period of time. The terms are agreed upon between the employer and employee.
Grant Date – The date of agreement between employer and employee to give an option to own shares (at a later date).
Vesting Date –The date the employee is entitled to buy shares, after conditions agreed upon earlier are fulfilled. This date is also agreed on grant date.
Vesting Period – The time period between the grant date and vesting date.
Exercise Period – Once stocks have ‘vested’, the employee now has a right to buy (but not an obligation) the shares over a period of time. This period is called exercise period.
Exercise Date – The date on which employee exercises the option.
Exercise Price – the price at which employee exercises the option. This price is usually lower than the prevailing FMV (fair market value) of the stock.An employer and employee agree on ESOP terms on the grant date. Once the employee has fulfilled the conditions or the relevant time period has elapsed, these employee stock options are vested. At this time the employee can exercise them or put simply – buy them. The employee is allowed some time period during which this option to buy can be exercised. Once the employee decides to buy, these stock options are allotted to him at an exercise price which is usually lower than the FMV of the stock. Of course the employee can choose not to exercise his option. In that case, no tax is payable. 

Calculating Taxes

ESOPs are taxed at 2 instances –

At the time of exercise – as a perquisite. When the employee has exercised the option, basically agreed to buy; the difference between the FMV (on exercise date) and exercise price is taxed as perquisite. The employer deducts TDS on this perquisite. This amount is shown in the employee’s Form 16 and included as part of total income from salary in the tax return.

At the time of sale by employee – as a capital gain. The employee may choose to sell the shares once these are bought by him. If the employee sells these shares, another tax event happens. The difference between sale price and FMV on the exercise date is taxed as capital gains.

Exercise price ——-<Perquisite>——-FMV on exercise date——<capital gains>——sale price

At the time of UnitsDateExercise PriceFMV of share*Tax impactRate of taxTax to be paidIn income tax return
Grant1001-Apr-12100120nilnilnil
Vesting1001-Apr-14100150nilnilnil
Exercise1001-Jul-14100170Taxable amount = FMV on Exercise date (1st July 2014) less Exercise PriceIncome tax slab rateTax = 30% x 100 shares x (Rs 170 - Rs 100) = Rs 2100 and 3% cess on itUnder Income from Salary
Sale of shares if listed201-Oct-14250Taxable amount = Sale Price on date of sale less FMV on exercise date15% on short term capital gainsTax =15% x 20 shares x (Rs250 - Rs170)= 240 and 3% cess on itUnder Capital Gains (short term capital gains)
Sale of shares if listed801-Sep-16300nil, long term capital gains on listed shares is exempt from taxlong term capital gains are exempt nil, long term capital gains on listed shares is exempt from taxExempt Income
Sale of shares if unlisted201-Oct-14250Taxable amount = Sale Price on date of sale less FMV on exercise dateIncome tax slab rateTax =30% x 20 shares x (Rs250 - Rs170)= 480 and 3% cess on itUnder Capital Gains (short term capital gains)
Sale of shares if unlisted801-Sep-16300Taxable amount = Sale Price on date of sale less FMV on exercise date20% tax on long term capital gains after indexation of costTax = 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 itUnder Capital Gains (long term capital gains)

How to calculate FMV

ESOP

Advance Tax on capital gains

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.

For financial year 2015-16 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. See more details about advance tax here.

Non payment or delayed payment of advance tax results in penal interest under section 234B and 234C.

However, it may be hard to estimate tax on capital gains and deposit advance tax in the first few installments if sale took place later in the year. Therefore when advance tax installments are being paid, no penal interest is charged where installment is short due to capital gains. Remaining instalment (after sale of shares) of advance tax whenever due must include tax on capital gains.

Other considerations involved

To properly calculate tax on sale of ESOPs certain other aspects need to be considered as well.

Short term or long term gains

At what rates your capital gains shall be taxes depends upon your period of holding. Period of holding is calculated from exercise date up to the date of sale. Equity shares listed on a recognised stock exchange (where STT is paid on sale) are considered long term when held for more than 1 year. If these are sold within 1 year, these are considered short term. Currently, long term gains on listed equity shares are tax free. And short term gains are taxed at 15%.

When you have incurred a loss

In case you have incurred a loss you are allowed to carry forward short term capital losses in your tax return and adjust & set them off against gains in future years.

Long term loss on equity shares is a dead loss and has no treatment, simply because gains are not taxable as well.

Listed or unlisted shares

The income tax act differentiates between tax treatment of listed and unlisted shares. The tax treatment of shares which are unlisted in India or listed out of India is the same. So if you own shares of an American company and therefore not listed in India, those may be considered unlisted for the purpose of taxes in India. These shares are short term when held for less than 3 years and long term when sold after 3 years. 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.

Starting FY 2016-17, UNLISTED equity shares shall be

short term capital assets – when sold within 24 months of holding them

long term capital assets – when sold after 24 months of holding them

[Applicable for sales made on or after 1st April 2016.]

Tax treatment of listed shares is mentioned above.

Residential status

Your income is taxable in India according to your residential status. If you are a resident, all your incomes from anywhere in the world are taxed in India. But if you are a non-resident or resident but not ordinarily resident and have exercised your options or sold your shares, you may have to pay tax outside of India. In such a case, you may be able to take benefit of double tax avoidance treaty or DTAA. Which makes sure your income is not taxed twice.

Disclosures

Several disclosures have been added in 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, employee can choose to not exercise his option. In such a case there shall be no tax implication for the employee.

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