The tax implications of an ESOP have a significant impact on the company's employees. The taxation laws that apply to a multinational corporation differ from one country to another.
The Impact of Taxes on ESOPs
ESOPs were initially taxable under the fringe benefits tax. However, subject to amendments made after the Finance Act of 2009, the taxability of ESOPs is in the hands of the employees.
Taxability from the perspective of the Employer
In India, there has always been a general sense of ambiguity about the deductibility of ESOP expenses. It has always been a source of contention. In the employer's case, because the ESOP discount is a general expense, the point of contention has always been whether it should be treated as a general provision under Section 37 of the Income Tax Act of 1961.
Section 37 (1) allows a deduction for expenses that are neither personal nor capital in nature and are not covered by Sections 30 to 36. However, various judgments have been rendered in favor of the employer, stating that the expense incurred by the employer is to be treated as allowable.
ESOP Direct provides advice on the tax ramifications of stock option plans in a variety of circumstances, including trust management, multiple geographic locations, or varied employee residency statuses.
Exercise of Esop is taxed under the head salary (prerequisite), where the difference between the fair market value of the shares and the exercise price of shares is taxed as per the normal tax slab of the employee.
ESOPs in an employee's possession might be taxed in two different ways. First, it is considered a perk and is subject to income tax under the head salaries. Second, when the shares are sold after they have been exercised.
The employee must pay income tax at ordinary tax rates on the value of the employer's contributions to the plan, as well as capital gains tax on the increase in share value when they decide to sell their shares when an ESOP distributes actual shares of the company stock rather than paying out the value of the shares in cash.