Taxation of ESOPs.

In this article, we will discuss the amendment bought by the finance Act 2020 relating to Taxation of ESOPs.

  What is ESOPs:-

On a general note, ESOPs is an employee benefit scheme provided by the company being employer to its employee to acquire the share at subsidized price or at free of cost.

  How it works and its important terminology:-

 

o   The date on which company provide an option to employee to acquire certain number of shares at predetermined price is called “Grant Date”.

 

o   The period in which option can be exercised by the employee is

called as “Vesting Period”.

 

o   The date on which option is exercised by the employee is called as

“Exercise Date”.

 

o   The date on which share is allotted by the employer after expiry of vesting period is called “Allotment Date”.

 

o   The date on which employee sells the shares is called “Transfer Date”.

 

  Taxation of ESOP:-

ESOPs are taxable only at the time of allotment of shares by the company to it employees and at the time of transfer of shares by the employee to third party.

o   While Allotment of shares, perquisite value of ESOPs shall be taxable in the hand of employee under the head “Salary” in the year in which allotment is made. The value of perquisite shall be the difference between “Fair Market Value of share as on date of exercise of option and amount paid to company by the employee”.

 

o   While transferring the shares by the employee to Third party, the difference between consideration received [subject to section 50CA in case of unlisted company] and Fair Market Value as on date of exercise of option [which was taken to calculate perquisite] shall be taxable under the head Capital Gains.

 

  Determination of Fair Market Value (FMV) of Shares: -

The FMV of shares shall be determined as per rule 3(8) of Income Tax Rules, 1962. As per rule 3(8), there is separate calculation for Listed Company and Unlisted Company.

 

 

 

 

o   For Listed Company’s share – If the share of Employer Company is listed on one stock exchange, the average of opening and closing price of the share on the date of exercising the option shall be the FMV of the share. However, if there is no trading on the date of exercise of option, then closing price of the share on the date closest to the date of exercising of ESOP and immediately preceding such date shall be the FMV of the share. If the shares of the company are listed on more than one stock exchange, then above stated price shall be taken of the stock exchange which records highest volume of trading.

 

o   For Unlisted Company’s Share – FMV of the share as determined by the merchant banker on the date of exercise of the option. However, FMV of any date not more than 180 days old, can also be taken for this purpose.

 

Deduction of TDS by the employer on the perquisite value :-

Employer shall deduct TDS under section 192 on the perquisite value of ESOPs in the year in which allotment of shares is made. However, here there is one interesting and unique amendment bought by the “Finance Act 2020” where only liability to deduct TDS and payment of Taxes by the employee [in case of failure by the employer to deduct TDS], has deferred. Author believes that he has never seen such amendment ever before. This amendment is applicable only for eligible Start-ups only.

For Eligible Start-ups, all the following conditions should be satisfied:-

·        The Company should be incorporated between 01/04/2016 to 31/03/2021.

·        The Company should be working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.

·        Turnover of entity for any of the financial years since incorporation/ registration should not exceed Rs. 100 crore.

·        It must hold a certificate of eligible business from the Inter- Ministerial Board of Certification.

For better understanding of amendment, first let us see the sections where amendment was made by the Finance Act 2020:-

·     192 – Eligible start-ups shall be liable to defer the deduction of tax on perquisite value of ESOPs to subsequent years.

·     140A - Employees shall be able to defer the tax liability in respect of perquisite value of ESOPs to subsequent years.

·     191 - If employer doesn’t deduct tax in subsequent year, employee shall

be liable to pay tax directly.

·     156    -    If    employee      doesn’t     pay    tax    directly,      Assessing      officer     is

empowered to issue notice of demand.

 

 

 

From the above amendment, it is clear that section 17(2)(vi) has not been amended, the Income shall still be computed in the year in which shares is allotted but deduction of TDS by employer (Eligible Start-ups) and in case of failure to deduct TDS, the payment of Tax by employee has been deferred. As per amendment made by Finance Act 2020, the Liability to deduct TDS by employer and in case of failure to deduct TDS payment of Tax shall be made within 14 days from the happening of any the following events (whichever is earlier):

·        From the expiry of 48 months from the end of Assessment year in which shares are allotted under ESOPs;

·        From the date the assessee ceases to be the employee of the organization; or

·        From the date of sale of shares allotted under ESOP.

It is also noted that liability of Tax shall be computed on the basis of rates in force for the financial year in which shares are allotted.

  Taxation of ESOPs on transfer of shares to third party:-

When an employee sells shares allotted under ESOP, the resultant gain or loss shall be taxable under the head capital gains. For computation of capital gain, following provisions are relevant:

·     Period of holding – From the date of allotment of shares to date of transfer of shares

·     Cost of acquisitions – Fair Market Value of shares as on date of Allotment of shares i.e., which was considered for calculating perquisite value of shares.