ESOP Taxation After Budget 2020

Employee Stock option Plans (ESOPs) are a part of employee benefit plans which are offered to give them an ownership interest in the organization. With ESOPs, Employees get a chance to invest something more than just their time and effort.

But how do ESOPs work?

First of all, it is the employer who decides which employee can avail the ESOPs. The employee is given a contract where there are a specified number of shares and the quoted price at which the employee can purchase the shares. The price is generally a modest sum, which is quite cheaper than the actual market price. Also, the contract specifies the period, on completion on which, the employee is allowed to exercise his employee benefit plan. This period is called as the vesting period and the date on which he can exercise his option is called as the vesting date. The price at which he can buy the shares is called as the exercise price.

For instance, an employee, Mr Sanjay is offered an ESOP by his organization, Tata Motors. The market price is rs.160, but he can purchase 3000 shares of Tata motors at rs.20. The contract has specifies the option period as 2.5 years. Here, 2.5 years is the vesting period. Rs.20 is the exercise price. Meaning which, Mr Sanjay can exercise the stock option plan only on the completion of 2.5 years, after the contract has been offered and at the exercise price i.e Rs.20,if he thinks it is a good investment.

As ESOP is considered as an employee benefit plan or a perquisite, it was earlier taxed as a part of salary on purchase of the shares. This means that Mr Sanjay has to pay tax on the purchase of shares for the quantity he purchases, but the price of shares is considered as rs.160 for taxation purposes. Here, the employee considers it unfair as he hasn’t even liquefied the stocks yet. Also, there is a second part to the tax. Mr Sanjay also has to pay long term capital gain tax on the profit earned when selling the shares.

The taxation is now eased down, in the Budget 2020, presented by the Finance Minister, Nirmala Sitharaman . As per the new and amended rules, now the both the parts of the taxes are to be paid at the earliest of the following:

·         Employee’s exit from the company, or

·         Selling of the shares, or

·         5 years after buying the shares

The tax has to be deposited within 14 days of the earliest of the above mentioned events.

Talking about the eligibility, the amendment in taxation is applicable only to startups incorporated after 2016, and applies only to the employees of the companies, which qualify as eligible startups under the section 80-IAC. To qualify as eligible startups, they have to be recognized under the Inter-Ministerial Board (IMB) of the government.

There are about 28713 startups in India, as on 19^th February,2020 , as per the Department for Promotion of Industry and Internal Trade (DPIIT). But those recognized under the IMB are only about 200. This means that the amendment is applicable to less than 1% of the actual number of startups in the industry.

This change is done to ease the cash flow problems of the employees. The change for making ESOPs taxable only at the time of sale was proposed by the DPIIT. The proposal has been accepted and will be affective from the next financial year i.e. 1^st April,2020.

Thank you.

Regards,
Nishi Sanghvi,
Kautilya,
IBS Mumbai