Taxation of Employee Stock Option Plan

Getting ESOP as a Salary Package? Appraise yourself about ESOP Taxation

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 organization 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 going through the taxation of ESOPs and RSUs, here are some key terms which everyone 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 prerequisite – When the employee has exercised the option, basically agreed to buy; the difference between the FMV (on the 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