The ESOP Guide | Part 3 Decoding tax for ESOPs

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ESOP Guide

Table of Contents

Employee Stock Ownership Plans (ESOPs) allow employees to own equity shares of the company or take part in a profit-sharing scheme. How does this benefit employees? To begin with, owning shares could generate remuneration that surpasses an employee’s pay package. And this can become a major source of motivation for employees to work towards the company’s success as they would directly benefit from the company reaching its financial goals. 

While ESOPs help organisations attract the right kind of talent, it also helps companies stay afloat as seen during the economic crisis triggered by the COVID-10 pandemic. When a crisis hits some companies with ESOPs let their employees liquidate the shares they own in order to make up for the pay cuts and layoffs. In other words, ESOPs act as potential safety nets that boost employee morale, while creating a company culture that drives employees to gainfully work towards the organisation’s wellbeing! 

ESOPs come with their own tax implications – two to be precise. The first tax implication occurs when an employee exercises their right to purchase a company’s share. And the second occurs when the employee is willing to sell their acquired shares. 

Read This – The ESOP Guide | Part 2 How ESOPs work as a talent magnet! 

To elaborate, when an employee chooses to exercise his/her tax options, the gain is credited to their salary and is taxed by the employer. At this time, if the company is listed in India, the value of the share assumes the average market value of the company’s share. Alternatively, if the company is not listed, a merchant banker is approached to obtain a certificate that estimates the shares market value.

Now in case the company happens to be listed at a foreign exchange, the process of ascertaining its value would be the same as in the case of an unlisted Indian company – you’d go to a merchant banker to estimate the market value of the allotted shares. Once the value of the share is obtained and the purchasing right is exercised by the employee, tax is calculated based on the tax bracket the employee falls under. 

The second tax implication as stated earlier occurs when an employee chooses to sell his/her shares. Here employees become liable to capital gains taxes. The tax rate itself depends on the duration the employee held these shares. Based on the duration it is determined whether Short-term Capital Gain (STCG) or Long-term Capital (LTCG) gain taxes are applicable.

Related Post – The ESOP Guide | Part 1 Types of ESOPs

The tax rate will depend on the duration the employee held on to their shares – accordingly, STCG or LTCG taxes will be applicable. If the stocks are sold within one year, it is considered to be a short-term gain and taxed at 15%. The present tax rates for long-term gains, shares held for more than a year, on listed equity stands at 10% without adjusting it to LTCG above ₹1,00,000. 

Another factor to keep in mind would be to see if the shares held are listed on a foreign exchange. Such holdings are treated just like domestic unlisted shares and taxed depending on the duration they were held – LTCG or STCG. It’s best for employees to do their due diligence by identifying any tax deductions based on international law to avoid double taxation. 

Next Article- The ESOP Guide | Part 4 Lifecycle of ESOPs

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