How Employee Stock Options (ESOP) are taxed in India?
Many companies use Employee Stock Options Plan (ESOP) to compensate, retain and attract employees. These plans give employees the right to buy specific number of shares of the company at a fixed price within a certain period of time. Employees hope to profit by selling the shares at a higher price than the price at which it was granted to them.
During falling equity markets between 2008-09 many employees allowed their Stock Options to lapse as they feared that the market price at a later date could fall below the option price. However, in rising equity markets since mid 2009, the ESOP has come back into vogue in a big way.
Earlier ESOP gains, which attracted Fringe Benefit Tax, were paid by the companies (recoverable from employees). Now (from 01.04.2009) ESOP gains are taxable on the gains made by the employee. In general capital gains taxes are calculated based on three factors. Buy & Sell Date, Buy & Sell price and holding period. To know more on how capital gains are taxed in India visit here. In case of ESOP, cost price & Buy Date are determined in a slightly different method.
Let us now see how the ESOP gains are presently taxed under Indian Income Tax Act. Before getting into this let’s understand some key terms that are used in capital gains for ESOP.
| # | Term | Explanation |
| 1 | Fair market value | Average of the opening and closing price of the share) on the date of redemption of shares from employer. |
| 2 | Exercise price | The price on which the share was allocated to the employee |
| 3 | Sale Price | The price on which the employee sells the share in the stock exchange |
| 4 | Virtual Gain | This is the virtual gain made by the employee. (#1 – #2) |
Example
Let’s see how Vivek’s (working for XYZ Company) earnings from ESOP are taxed.
- Vivek has been granted 500 Stock options by his employer in July 2008
- Allotted price of Rs.100 per share (exercise price)
- Vivek exercised (redeemed) entire stock options in July 2009
- The share price was Rs.250 on the day of redemption (Fair market value).
- He later sold the entire shares in the stock exchange in January 2010
- @ Sale price of Rs.450 per share.
| # | Particulars | Rs. | Comments |
| 1 | Stock Option Price (Exercise price) | 100 | The share was priced at this value by the employer. |
| 2 | Share price on the day of redemption (fair market value) | 250 | |
| 3 | Virtual Gains | 75,000 | Actual stock price is 250/- but employer provides the same for 100. So the employee has a gain of 150/- per share. (500 * 150 = 75,000) |
| 4 | Tax on Virtual Gains (@ 30.9 %2) | 23,175 | This is paid by the employer and deducted as TDS from employee. |
| 5 | Sell Price | 450 | Vivek sold the shares at this price. |
| 6 | Profit made during the sale transaction | 1,00,000 | Rs. 200/- per share (#5 – #2) |
| 7 | Tax on short term capital gains (@ 15.45%) on 1,00,000 | 15,4501 |
1 In case if Vivek holds the shares for more than 12 months from the date of exercise, it will be a long term capital asset and the capital gains will be fully exempt from tax. He doesn’t have to pay the Rs.15,450 shown in #7 above.
2 Assumed for highest tax slab and employer is listed company
Updated for FY 2009 – 2010
Thank you for the information. What I am not able to understand is, from 01/04/2009 is the virtual gains (#3) also taxable instead of the employer paying it?
Yes. Employer will deduct the tax from your salary (as TDS).
Sir I have one query on the above example. What if Vivek sells his share on the same day after he redeemed i.e. if he sells at 250 on the same day.
what if the shares are not listed on stock exchange and are bought back by the promoters at a particular price giving you a gain. How do we calculate fair market value especially for shares vested before 01/04/09
In case of individuals whose residential status is non-resident/not ordinarily resident and who have worked overseas during the period of the ESOP. How the esop will be taxed, The company has witheld foreighn tax as well as indian tax
I am facing a similar situation i.e. being taxed twice. Wouls appreciate a response to Aditya’s query