Everything you need to know about taxation of ESOPs

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Employee Stock Ownership Plans(ESOPs) and Restricted Stock Units (RSUs) have been a great wealth creator for many employees who benefited from them.  It’s hardly surprising why it’s a hype – startup, or otherwise. However, it is important to understand the taxation, lest a good part of the gain is paid out in taxes.  Today, the pay cuts are all the more reason for you to squeeze out the best from your ESOPs. In this article, we’ll glaze over a few key terms and discuss the basics of ESOP taxation.

ESOPs terms-to-know:

  • The date your employer issues you ESOPs is the grant date.
  • The date you’re entitled to buy the shares is the vesting date.
  • And the time between the grant date and the vesting date is the vesting period.
  • After you’ve vested, the date you exercise the option is the exercise date
  • The exercise price is the amount at which you exercise the option, which is usually lower than the FMV (Fair Market Value is the price at which the share is traded for a listed company).

Simple enough. No doubt, you may choose to not exercise the option immediately. In which case no tax is payable till you exercise the option. 

There are two stages of taxation of ESOPs.  Let us see how they work:

  • On Exercise: the difference between the exercise price and the fair market value is added to income and taxed as a prerequisite.
  • On sale: The difference between fair market value and sale price is taxed as capital gains. Capital gains are taxed as follows: 
    • For Indian listed company shares: If held for a period of 12 months or less after exercise, this is treated as short-term capital gains, and taxed at 15%. After 12 months, the gains are called long term capital gains, and gains over one lakh are taxed at 10%. 
    • For unlisted company shares, ESOPs held for over 24 months are treated as long-term capital gains which are taxed at 20% with indexation; otherwise short-term capital gains are added to income.

Furthermore, if you own shares across borders, the taxation is the same as unlisted company shares.

This time of the year may also be a good time for you to think of these options within your company of employment. Since markets have done well in recent months, you may want to convert your paper profit into real profit!


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