Filing for AY 2024-25 is coming soon
Filing for AY 2024-25 is coming soon
Keep calm and sign up for early access to our super filing platform

Getting ESOP as Salary Package? Know about ESOP Taxation

Updated on: Mar 22nd, 2024

|

34 min read

social iconssocial iconssocial iconssocial icons

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.

How do ESOPs work?

Before you understand the taxation of ESOPs and RSUs, here are some key terms you must know:

  • ESOP – Employee Stock Option Plan, allows an employee to own equity shares of the employer company over a certain period. The terms are agreed upon between the employer and employee.
  • ESPP - Employee Stock Purchase Plan allows an employee to own equity shares of the employer based on the agreed purchase price. Employees pay for such stock at a discounted and is paid directly from their bank account or deducted on a monthly basis from the payroll or payslip.
  • RSU - Restricted Stock Units are usually issued by those companies listed outside India. In the case of RSU, employees need not pay any amount to exercise the stock and will be given free of cost from the employer.
  • Grant Date –The date of the agreement between the employer and employee to give the 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 the agreed-on grant date.
  • Vesting Period – The period between the grant date and the vesting date.
  • Exercise Period – Once options have ‘vested’, the employee now has a right to buy (but not an obligation) the shares for a period of time. This period is called the exercise period.
  • Exercise Date – The date on which the employee exercises the option.
  • Exercise Price – The price at which the 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 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 in 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 the 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 the total income from salary in the tax return.
    • Budget 2020 amendment – From the FY 2020-21, an employee receiving ESOPs from an eligible start-up need not pay tax in the year of exercising the option. The TDS on the ‘perquisite’ stands deferred to earlier of the following events:
      • Expiry of five years from the year of allotment of ESOPs
      • Date of sale of the ESOPs by the employee
      • Date of termination of employment
  • At the time of sale by the 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 the sale price and FMV on the exercise date is taxed as capital gains. 

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)

How to calculate FMV

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.

FMV of 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 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.

Other considerations involved

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.

Related Articles

Tax deductibility of ESOP expenses

ESOP- the employer perspective

ESOP Vs Sweat equity share

Procedure for issue of ESOPs

Should you Opt for ESOPs?

How to report loss on ESOPs in income tax return?

Frequently Asked Questions

I have exercised stocks listed in the United States, and they have deducted the tax. How do I claim DTAA relief?

If you are a non-resident of the United States, you are not subject to any Federal tax (Income tax) at the time of exercise or at the time of sale (capital gain). Amount that you see which is deducted is a mechanism of ‘sell to cover transactions’. This involves the employer selling a part of the allotted stocks to pay for your Indian Income tax. Such deducted amount would have been transferred to your employer who will use the same to pay the TDS.

Since there is no double taxable, question of DTAA relief does not arise

I work in an Indian Startup who bought back my options. Should I show this in my ITR?

Buyback of options will be considered as Salary income and thus employer would have done the TDS on the same. Such buyback value will be considered in your Form 16. Thus separate disclosure is not required.

Can I claim a capital gain exemption on the sale of my company stocks?

Yes. You can claim an exemption under section 54F, where the proceeds from the sale of such stocks are re-invested in the purchase of new residential house property (Subject to condition).

From tax perspective, is exercising in current FY better or next is also fine?

From Tax perspective exercise of stock option, such income will be considered as income from salary and will be tax in the year of exercise at your respective slab rates.

I have received dividend income on stock listed in the U.S.A. They have deducted 25% tax. How to treat this in Indian ITR?

Dividends issued by the U.S.A. corporation are subject to a Federal tax of 25%. For Indian Tax Resident, Global Income is taxable in India thus, you are supposed to include such dividend income also in your ITR. Since you are subject to double tax both in India and the U.S.A., you can claim the relief u/s 90 as per Article 10 of India-U.S DTAA on the taxes which are already paid in the U.S.A. You have to file Form 67 before filing your ITR to claim the credit for the same.

I have sold shares listed in the U.S.A. Which exchange rate should I consider for conversion from USD to INR?

As per Rule 115 of the Income tax rule Exchange rate is decided as follows- the last date of the preceding month in which such capital gain is incurred. For example, if you sold shares on 15th Mar 2024, Then you need to use the 29th Feb 2024 exchange rate.

Such exchange rate will be multiplied by the capital gain (U.S.D) to convert the value to INR.

I have the unvested stock option (Company listed in the U.S.A.) Am I supposed to declare the same in Schedule FA?

No, the Unvested stock option means you have not yet satisfied the condition of the vesting and equity shares are not yet allocated on the same. Since you are not holding any equity shares, you need not declare the same in Financial Equity or Debt Interest in Schedule FA.

CONTENTS

Clear offers taxation & financial solutions to individuals, businesses, organizations & chartered accountants in India. Clear serves 1.5+ Million happy customers, 20000+ CAs & tax experts & 10000+ businesses across India.

Efiling Income Tax Returns(ITR) is made easy with Clear platform. Just upload your form 16, claim your deductions and get your acknowledgment number online. You can efile income tax return on your income from salary, house property, capital gains, business & profession and income from other sources. Further you can also file TDS returns, generate Form-16, use our Tax Calculator software, claim HRA, check refund status and generate rent receipts for Income Tax Filing.

CAs, experts and businesses can get GST ready with Clear GST software & certification course. Our GST Software helps CAs, tax experts & business to manage returns & invoices in an easy manner. Our Goods & Services Tax course includes tutorial videos, guides and expert assistance to help you in mastering Goods and Services Tax. Clear can also help you in getting your business registered for Goods & Services Tax Law.

Save taxes with Clear by investing in tax saving mutual funds (ELSS) online. Our experts suggest the best funds and you can get high returns by investing directly or through SIP. Download Black by ClearTax App to file returns from your mobile phone.

Cleartax is a product by Defmacro Software Pvt. Ltd.

Company PolicyTerms of use

ISO

ISO 27001

Data Center

SSL

SSL Certified Site

128-bit encryption