Employee stock options (Esops) have been traditionally used by companies to reward and retain key employees. The benefits from Esops are taxed under various heads such as salary, capital gains, fringe benefit tax etc. The mishmash of taxation makes it difficult for the taxpayer to know the impact on his Esops. The present scheme of taxation is as follows:
Types of Esops:
Though Esops are allotted under various names such as sweat equity, restricted stock units, stock purchase plan, stock appreciation rights etc, the law classifies Esops into two types. First, this benefit can be handed out as a notional stock where no shares are allotted, but an amount equivalent to the value of a company's shares is paid to employees. Second, Esops become real stock when shares are allotted. In the case of real stock, the taxman does not differentiate if the underlying security is an equity share, preference share or American depository receipt. The tax treatment is the same even if a company directly allots shares or though a trust.
Stages of taxation:
The income arising on notional stock is taxable as salary when the amount is received. In the case of real stocks, the benefits are taxed in two separate stages. When Esops are exercised, or converted into shares after paying the price, they are taxable as salary. They are also taxed as capital gains during sale of allotted shares if there are additional benefits at the time of sale.
Value for tax purpose:
In the case of notional stock, the value for tax purposes is the amount the company pays to the employee. In the case of real stock, the value for tax is again arrived separately in two stages. The first is at the time of conversion of Esops into shares. Here, the difference between the fair market value (FMV) of the stock allotted and the amount recovered (the exercise price, what employees pay to convert options into shares) from the employee is taxed as salary in the hands of the employee. The FMV of the Esops depends on whether the shares are listed in India or otherwise. If shares are listed on a recognised Indian stock exchange, FMV would be linked to the market price of the shares on (or closer to) the date of exercise.
In case of other shares (including those listed on overseas bourses), the FMV is determined by a Category 1 merchant banker registered with the Securities and Exchange Board of India. The value so determined can either be on the date of exercise or any date up to 180 days prior to the date of exercise. Accordingly, even if there is no tangible benefit to employees at the time of exercise, they still have to pay income tax on the FMV of the shares (less any amount recovered).
Employees are also taxed when shares are sold within a year of allotment. Here, the difference between the sale price and FMV is taxed as capital gains. So, in case an employee sells immediately after shares are allotted, there would be no gains and accordingly, no tax implications (assuming there is no fluctuation in the FMV of the shares between exercise date and sale date). But if an employee sells shares after a certain period, there could be gains or losses depending on the price at which the shares are sold.
