Employee Stock Option Plan (ESOP) has been an attractive tool to attract and retain key employees by an organisation and generally ESOP’s constitute a significant component of compensation for employees especially for Start Up’s.
ESOPs are taxable as perquisites at the time of exercise at fair market value (FMV) reduced by the consideration received from employees towards acquiring such ESOP shares u/s 17(2)(vi) of the IT Act, 1961 (The Act).
Further, when the employees transfer such ESOP shares, it leads to capital gain in the hands of such employees for the value at which the ESOP shares are sold reduced by the FMV of such shares at the time of exercise.
To illustrate with an example, if an employee receives 1000 shares under ESOP having a FMV of Rs.100/- per share from his employer company at the rate of Rs. 40/- per share (amount paid by the employee to acquire such shares), the value of perquisite subjected to tax u/s 17(2)(vi) shall be Rs. 60,000 [1000 ESOP shares X (100-40)].
Further, when such an employee sells the 1000 ESOP shares for Rs. 200/- per share, the capital gain to such an employee will be Rs.1,00,000/- {total sale consideration Rs.2,00000 (1000 ESOP shares @ Rs.200/- share) less FMV of the shares acquired under ESOP (1000 ESOP shares @ FMV at the time of exercise Rs.100/- share)}.
There is generally significant time gap between the time of exercise of ESOP by a employee and when he actually sells off these shares (if he ever sell). The employee is subjected to taxation on the notional gain which he earns at time of exercise as a difference between the FMV of share and the value at which is received by him. The employee may or may not have such salary to have deduction of taxes to pay for the tax on perquisite and even assuming that he has such salary wherefrom the TDS on perquisite could be deducted but this will mean less cash flow to the employee at the time of exercise of ESOP on the notional gain made by him.
Budget proposal for ESOP
The Budget 2020 has brought in an important change in the taxation of the perquisite value of shares received under ESOP of the eligible start up’s. Section 192 of the Act has been amended to insert sub-section (1C) requiring an eligible start up referred to in section 80-IAC, responsible for paying any income to the assessee u/s 17(2) of the IT Act 1961 in any previous year relevant to the AY 2021-22 or subsequent AY’s , deduct or pay, as the case may be, tax on such income within fourteen days —
whichever is the earliest on the basis of rates in force of the financial year in which the said specified security or sweat equity share is allotted or transferred.
Corresponding changes have also been carried out in section 191 (assessee to pay the tax direct in case of no TDS), section 156 (notice of demand) and section 140A (calculating self-assessment tax). All these amendments will take effect from 1st April, 2020.
This is an important change brought in taxation of perquisite because the current regime for ESOPs taxation , which trigger a perquisite tax on the notional gain on the exercise of the stock options at fair market value, makes the entire proposition of ESOPs unattractive.
The amendments however does not propose any change to the substantive provisions under section 17(2)(vi) of the Income-Tax Act, 1961. It only defer the payment of the tax on perquisite by employees to be paid within 14 days of any of these events which ever is earlier taking place, independently.
In essence the provisions provide more time to the employee to liquidate his or her shares and arrange money to pay the perquisite tax incurred on the exercise of the ESOPs. Also the amended provisions address a very restricted group of assessee and the provisions is marred with certain shortcomings.
The amended ESOP tax provisions retains the charterer of the earlier law of taxation of the notional perquisite income in the hands of the tax payer, with a deferral on the payment of tax on perquisite value for a very limited entities being eligible start up’s.
Manava Prem
Partner
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