Taxability of ESOP Under the Income Tax Act

Taxability of ESOP Under the Income Tax Act

Introduction of Taxability of ESOP Under the Income Tax Act

A company's Employee Stock Option Plan (ESOP) allows them to buy the company's shares at a much lesser rate compared to the market price. Generally, startups use the ESOP plan to attract the big wigs among employees because startups do not usually have a lot of money to play with. Companies can pay relatively lower salaries while offering ESOPS and other options as incentives. The taxability of ESOP under the income tax act follows how taxes are imposed on these ESOPS, provided to the employees.

How are taxes implemented in ESOPs?

Before the Finance Act of 2009, ESOPs were subject to fringe benefits tax (FBT). However, as a result of changes made following the Act, the taxability of ESOPS has now been shifted to employees.

The taxability of ESOP under the income tax act is implemented in the following ways:

  1. Tax on perquisites. This is implemented at the time of the option when shares are provided to the employees.
  2. Tax on the capital gain. This implements when employees sell their shares.

Taxation at the time of buying shares

Perquisites are the difference between the face market value (FMV) of the allotted shares and the price at which they are given as ESOPs. According to the Income Tax Rule 3(8), 1962, fair market value (FMV) is calculated by taking the mean of the maximum and minimum selling prices of the day. 

Perquisites are deducted by the process of TDS on salary. However, according to the recently announced amendments in budget 2020, the taxability of ESOP under the income tax act changed. 

Amendment of Budget, 2020 - From the fiscal year 2020 to 2021, no tax will be applied to employees receiving ESOP from an eligible start-up in the year of exercise of the option. The TDS is deferred to the earlier of the following events:

  • After five years since the employer slotted the shares.
  • The date on which the employee sells ESOP shares.
  • Date of retirement of the employee from the company. 

The employee doesn't need to exercise the given option. In such cases, the taxability of ESOP under the income tax act will not prevail. When share prices drop, it is up to the employee whether to exercise or let the option lapse. 

Taxation at the time of selling the shares

Once shares are assigned to an employee’s name, he can either hold the shares or sell them to incur profit. The tax imposed on his gains is called capital gains tax. Rates of capital gains tax can differ depending upon the time for which the shares are held. These are mainly short-term capital gains and long-term capital gains.

Aside from this, the taxability of ESOP under the income tax act can be further divided according to the following situations:

For listed shares:

  • For shares under ESOP held less than or equal to 12 months, the resulting gains after the sale of such shares will fall under the short-term capital gains. Then, a concessional tax of 15% will be imposed following Section 111A of the income tax act, 1961.
  • For shares under ESOP held for more than 12 months, the gains resulting from the sales of such shares will fall under the long-term capital gains. The taxability of ESOP under the income tax act will be at the rate of 10% according to section 112A, 2018. If gains are more than 1 lakhs, indexation will not be provided.

For unlisted shares:

  • For shares held for less than or equal to 24 months, under STCG, the sale of those shares will incur regular income tax rates for the employee.
  • For shares held for more than 24 months, as per Section 112 of the income tax act, selling those shares under LTCG will incur a rate of 20% along with indexation.

Advance Tax imposed on capital gains

The advance tax states that the tax dues (estimated for the whole year) must be paid in advance, another rule to be followed for the taxability of ESOP under the income tax act. When an employee exercises his options, he may have to deposit advance tax if he decides to sell those shares. Failing to do so or delaying in payment of advance tax will result in additional interest according to sections 24B and 24C. He can avoid this by selling the shares in the following year, making a loss of capital gains. The remaining advance tax (after the sale of shares) must include capital gains tax whenever it is due.

Taxation based on residency

The taxability of ESOP under the income tax law also depends upon the employee's residency. Selling and buying the shares, under the ESOP plan, in his resident country will result in no additional tax. But selling ESOP shares in a country without a residential identity will attract another tax outside the country. In this case, the employee can exercise the Double Taxation Avoidance Agreement (DTAA) to prevent his income from being taxed twice.


The introduction of ESOPs is a hugely positive sign for small startups; it is a great way to refrain employees for the long term, giving a sense of ownership over the company. The taxability of ESOP under the income tax law is carefully constructed after considering the formation and regulation of ESOPs. Furthermore, the ESOP re-purchase program rewards employees of any establishment for their service contribution.

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