PROSPERR.IO

In the realm of employment benefits and remuneration, understanding the taxation of perquisites involving shares issued under employee stock options plans (ESOPs) is crucial for both employers and employees. The perquisites provided by an employer are taxable under the head income from "Salaries" under the Income-tax Act in India unless specified otherwise under the Act or Rules made thereunder. The value of shares issued under ESOPs by employers to an employee at a discount or free of cost is considered taxable perquisites in terms of clause (2) of Section 17 of the Income-tax Act.

It is also necessary for employees to understand the tax consequences of the subsequent sale of such shares.

In this article, we delve into the intricacies of how shares issued under employee stock options are taxed at the time of exercising the options and at the time of sale of such shares. Let's explore–

How is the fair market value of shares issued in ESOPs determined?

The fair market value (FMV) of ESOP on the date of exercise of the option by the employee is determined as follows:

(1) If the shares are listed on a recognized stock exchange, the fair market value (FMV) shall be the average of the opening price and closing price of the share on that date on the stock exchange with the highest volume of trading and if no trading occurs on the exercise date, the closing price of the closest preceding date to the date of exercising the option.

(2) If the shares are not listed on a recognized stock exchange, the fair market value (FMV) shall be valued as determined by a merchant banker on the date of exercise of the option or an earlier date, which is within 180 days of exercising the option.

How is the perquisite value of such shares computed for taxation under the head income from “Salaries”?

When an employee exercises the ESOPs, the difference between the FMV of the shares on the exercise date and the amount actually paid by the employee (if any) is treated as a perquisite. This perquisite value [FMV of shares (-) amount paid by employee, if any] is added to the employee's income under the heading "Income from Salaries" for taxation purposes.

Example: In case of Mr. Mahesh, an employee of ABC Ltd, the following particulars are available:

• Date of Exercise of ESOP: May 1, 2024
• FMV of Company ABC Ltd. shares on May 1, 2024:
• Opening price in the stock exchange : ₹100 per share
• Closing price in the stock exchange : ₹110 per share
• Number of shares allotted through ESOP: 1000 shares
• Exercise price (amount paid by the employee): ₹50 per share

Step 1: Determine Fair Market Value (FMV) of Shares on Exercise Date:

Since the shares are listed on a recognized stock exchange:

• FMV = (Opening price + Closing price) / 2
• FMV = (₹100 + ₹110) / 2
• FMV = ₹105 per share

Step 2: Calculate Perquisite Value:

• Perquisite Value = [FMV per share (-) Exercise price] multiplied by Number of shares allotted
• Perquisite Value = (₹105 - ₹50) multiplied by 1000 shares
• Perquisite Value = ₹55 multiplied by 1000
• Perquisite Value = ₹55,000

Step 3: Include Perquisite in Taxable Income:

The computed perquisite value of ₹55,000/- will be added to the employee's income under the heading "Income from Salaries" for the financial year 2024-25 relevant assessment year 2025–26.

By following the above steps and understanding the relevant rules outlined in the Income Tax Act, employers and employees can correctly compute and manage the taxation of perquisite values associated with Employee Stock Options in India.

How is the profit from the sale of such ESOPs computed and taxed?

When the employee eventually sells the shares received through ESOPs, any capital gains arising from such sales are subject to tax under the heading “capital gains” in the assessment year relevant to the financial year in which such shares are sold.

The capital gains are calculated as the difference between the sale price of the shares and the FMV of the shares as determined at the time of exercise of the options (i.e., the cost of acquisition for the purpose of computing capital gains).

• If the shares are held for more than 24 months, the gains will be treated as long-term capital gains (LTCG) and taxed at a concessional rate, currently at 20%.
• If the shares are held for 24 months or less, the gains will be treated as short-term capital gains (STCG) and taxed at the applicable income tax slab rates of the individual.

Conclusion

It's essential for employees participating in ESOP schemes to seek guidance from tax experts to understand their specific tax liabilities and optimize their financial planning accordingly. Additionally, tax laws and regulations governing ESOPs may evolve, necessitating regular updates and compliance with the latest guidelines. Understanding the tax implications upfront empowers employees to make informed decisions regarding their ESOP benefits and potential future gains. Click here to book your FREE tax assessment call

Disclaimer:

The article is only for educational purposes, covering limited aspects of relevant provisions of the Income-tax Act. The relevant provisions of the Income-tax Act may be referred to, for complete understanding.