Employee Stock Options: How it works and understanding tax implications

Employee Stock Options: Every company hires talent that will help it to expand the business. While hiring employees, companies provide them with certain perks. One among them is the Employee Stock Option Plan or ESOPs. While it may seem to be a good incentive, it comes with challenges as well and one of them is filing tax for ESOPs.

What are ESOPs?

ESOPs are the company’s stock provided to the employee at a low or no additional cost. These are perks provided in order to attract or retain employees.

According to Nirvi Ashar, fundamental analyst, Religare Broking, ESOPs motivate employees and make them responsible. “ESOP serves two purposes. On one side the employee is motivated, whereas, on the other side the employee feels responsible and works towards performance improvement of the company,” she said.

She added that ESOPs are given to a certain set of employees as decided by the company’s management.

Tax on ESOPs

As per the provisions of Income Tax Act, 1961 (the Act), the tax implications of ESOP get triggered at two stages — at the time of exercise of options and then at the time of sale of shares.

Exercise of Option

In the Exercise option, ESOP is taxed under the head salary (perquisite), here the difference between the fair price of the shares and its issue price is taxed as per the normal tax slab of a salaried individual

“ESOPs at the time of its exercise form part of the salary. The price of its issue is pre-determined and the difference between the fair price of the shares and its issue price becomes a prerequisite, which forms part of salary in the hands of the employee. The tax is computed along the same lines of salary income,” Archit Gupta, Founder and CEO, ClearTax explains

Sale of allotted share

Allotted shares sold by an employee are taxed under capital gains tax as ESOP is considered as a capital asset and any gain on sale of such shares would attract capital gain tax. The tax is applied on the difference between the sale price and purchase cost. The purchase cost for this purpose is Fair Market Value– current price that a buyer in the open market is willing to pay up to purchase a certain asset, of the shares as on the date of exercise of options which was considered for computation of perquisites tax as discussed above.

Also Read: HDFC Bank FD interest rates 2023: Earn up to 7.75% return on fixed deposit

How to calculate Tax on ESOPs

According to Archit, the capital gains on sale of the shares issued under ESOP which are listed in India shall follow the same principle of capital gains of equity shares u/s 111A (Short Term Capital Gain) or 112A (Long Term Capital Gain).  

He, however, added that the shares of foreign entities, issued under ESOP shall follow the principle of taxation of unlisted shares, as they are not listed in any recognised stock exchanges in India. To compute the gains appropriate foreign exchange rates are to be considered as well.

Factors to be considered before filing ITR for ESOPs

1. ITR 2/3 form shall need to be selected for filing ITR

2. Foreign shares issued under ESOP shall need to be disclosed in the ITR in schedule FA whether or not they have been sold

3. Further disclosure of foreign ESOPs are to be made in the general schedule of the ITR

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