Tax Implications of ESOPs for Startup Companies in India

Tax Implications of ESOPs for Startup Companies in India

In India, startups are an essential element of the corporate environment. The startup sector expects extra tax breaks on ESOPs in the next budget. Let's examine how the taxation of ESOPs values and helps new businesses.

As all the startups know, ESOP is a capital asset. Any earnings on the sale of such stocks will increase capital gain tax. Hence, authorised shares traded by an employee are subject to capital gains ESOP taxation. Employees in the ESOP plan buy business equity at a discount.

How does ESOP taxation work?

The Income Tax Act of 1961 imposed the ESOP tax twice, once during option execution and again upon share sales. At the moment of share sales, startups are pushing for the imposition of ESOP taxes. Currently, we process the taxes in two stages.

The Taxation of ESOPs

Tax levy on ESOPs twice, once during execution and once when employees sell shares.

The government taxes ESOPs as salary. The difference between the exercise price and the FMV is taxable. An employee's pay bracket doesn't matter.

Selling shares triggers capital gains. The difference between the execution and buy prices imposes them. You can use long-term earnings from ESOPs as a deduction under Section 54F. Homebuyers can apply this deduction to the buy of residential real estate. This is subject to specific requirements.

It is crucial to understand the relevant tax regulations. This will reveal the taxation of employees' income. This is important at many stages, including setting up an ESOP (gift, vesting, and exercise).

Capital assets: ESOP taxation considering factors

Listed on an established Indian stock exchange

Long-term capital gains are gains over INR 1,00,000 made in a given year. They are subject to 10% taxation plus any relevant surcharge and cess. They are not subject to indexation.

Gains on short-term capital are 15% taxed (plus any applicable cess and surcharge).

Not available on a reputable stock exchange

The tax authorities tax resident taxpayers at a rate of 20% (plus surcharge and cess). The government taxes non-residents at a 10% rate (plus surcharge and cess).

Total income includes short-term capital gains. They are subject to individual progressive tax rates.


The income tax return forms for overseas assets now include several extra disclosures. You might need to report your overseas interests under schedule FA of your income tax return. This is true if you have ESOPs or RSUs from a foreign corporation. Residents are subject to certain disclosure requirements.

When choices remain unexecuted

The employee becomes entitled to buy the stocks or execute his option on the vesting date. But, the employee is free to decide not to use his option; there is no obligation. There won't be any tax implications of ESOPs for the employee in this scenario.

Rules to establish an ESOP

When establishing an ESOP, entrepreneurs should bear the following in mind:

The ESOP paperwork should follow the Companies Act of 2013.

  • All directors must receive notice of the upcoming board meeting. At least seven days in advance.
  • Establish the share price: Pick the day and time. Permit to call a general meeting. The purpose is to approve a special resolution for the ESOP issuance. Adopt the resolution authorising the ESOP to issue shares.
  • Give each director a copy of the draft minutes after two weeks. If the board has adopted a resolution, file the MGT-14 form with the Registrar of Companies.
  • Call a general assembly: Notify the company's directors, auditors, shareholders, and secretarial auditors at least 21 days before the meeting.
  • Adopt a special resolution: This will allow the general assembly to approve issuing ESOP shares. Officers, directors, and workers of the company will receive ESOPs.

Startups install ESOPs to achieve the following goals.

Esop Taxation for Startups in India: A startup needs funding. One way to generate it is by offering employees stock in the business. This is a reward for their continued service.

In contrast, ESOP turns out to be a perfect stand-in that draws in, inspires, and retains employees.

It's like a profit-sharing plan. Workers who feel that they control and are part of the organisation are inclined to work hard. They also take initiative in the growth of the business.

Accessibility limits the shares. Using the plan is better than selling them on an inventory trade.

Five recommendations for you as you research ESOPs

Comparing ESOPs: You can check the compensation plans that various employers provide. Yet, contrasting the ESOPs of different companies is like contrasting apples and oranges. The companies are in different industries and phases of development. This might lead to wide variations in the potential rewards.

ESOPs' Value: This is also unclear. Employers report these options as "at-the-money." This term means the strike price is equal to the market price. They report them as "in-the-money." The holder can buy the options for less than the current market price. First, be sure you comprehend what is being provided to you.

Take note of the timeframes for when you will get these options (vesting). Also, note the timeframes for when you can exercise them to convert them into equity. It is ideal to work out for as long as possible and to vest as early as possible!

ESOP vs Cash: This is a personal and difficult decision. First, focus on securing a comfortable lifestyle for yourself and your family. After that, negotiate for the most ESOPs possible. Compromise on cash is acceptable if it suits your needs and you don't need the liquidity.

According to income tax laws, converting stock options into stocks creates income. This is because you spend very little or nothing on these stocks. Later, you can sell them for a profit. Thus, please pay attention to them.

Comprehending ESOP Tax: Example

Consider Karthik became one of the first workers of a startup company in 2017. Karthik received 10,000 ESOPs at an exercise price of INR60 per share upon joining. According to the policy, you may exercise the option for INR60 after three years or in 2020.

Karthik fulfilled her option in 2020. Each share's fair market value is INR 100 on the day of the exercise. Additionally, he chose to sell the shares in 2018 for $120 apiece. Suppose he is subject to the 30% tax rate. We will now examine the operation of the ESOP Taxation:

When the option is exercised, the following will be the initial tax rate:

The value of an ESOP on the date of allotment would be equal to (FMV per share ? Exercise price per share) x the number of shares granted. The government would tax ESOPs as perquisites.

Perquisite = (100 ? 60) X 10,000 = 400,000 INR; TDS = 30% X Perquisite = 1.2 lakhs INR (adjusted for appropriate cess and surcharge).

Karthik's income will include the INR4,00,000 perquisite value of the ESOP. It will be taxed in the year that the shares are allocated. On such an amount, the employer (Startup) is required to deduct TDS.

When ESOPs are sold, the following is the second tax rate:

Karthik would have to pay capital gain tax, which would be computed as follows if he were to sell the share in 2021.

Gains on sales equal the fair market value (FMV) of the shares at the time of share allocation.

10,000 x (120 ? 100) = Rs. 200,000

Karthik has owned the shares for less than a year (counting from the date of allocation). So, the gains will be short-term capital gains. They will be taxed at Karthik's regular slab rates.

What Advantages Come With Issuing An ESOP?

Benefits for Workers

Employee stock ownership plans, or ESOPs, give employees access to discounted share prices. Employees also receive dividend income and own stock. Workers can invest at a discounted rate. They can become co-owners of the business. They can also receive extra income as dividends.

Advantages For New Businesses

Startups can attract and keep bright workers and increase productivity by providing ESOPs. This is particularly important in the early stages when paying high salaries might not be possible. ESOPs also help to draw in new hires.

Advantages for Qualified Startups

Only workers of qualified startups are eligible for the tax payment deferment on ESOP requirements. The Department for Promotion of Industry and Internal Trade (DPIIT) has recognised over 88,000 startups. Yet, only 993 of them meet the requirements specified in Section 80-IAC of the Income-tax Act. These qualified startups can enjoy the tax deferral, which will positively impact their staff.


Experts expect India's next budget to offer more tax breaks for startup employee stock ownership plans (ESOPs). This would let startups put ESOP profits from share sales into a fund. We expect this move to reduce capital gain tax and attract staff. But don't worry if you can't deal with ESOP taxation; you can also make your startup shine. Thanks to Especia ESOP solutions, which help your startup achieve massive success.


What are the ESOP guidelines for startups?

Annual or quarterly vesting is available for ESOPs, with a typical vesting time of four years in India. The startup will only vest your ESOPs during the period of your employment. Thus, if you quit your employment in two years, you will still be eligible for ESOPs for those two years; after that, the remaining ESOPs will expire.

Does GST apply to ESOP?

Under ESOPs, the issuance of securities is not seen as a delivery of goods or services. So, GST does not apply to the same.

Who is ineligible for ESOP?

Employees who own more than 10% of the company, excluding directors and promoters, are all eligible for ESOP.


Contact Us for ESOP Services, ESOP for Startups, ESOP Financial Services, ESOP Advisory and ESOP E-Grants in Delhi, Noida, Gurgaon, and all across India: write to us at Or Call On :(+91)-9711021268 +91-9310165114

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