Meaning of ESOP –
ESOP is an abbreviation which stands for Employee Stock Option Plans. Under the ESOP plan, an employee (at his option) can acquire shares in the employer company at a reduced price after completion of a specified period of service.
Meaning of Sweat Equity Shares – It means equity shares issued by a company to its employees or directors at a discount or for consideration other than cash for providing know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called. Such shares may be equity shares, any other shares, scrips, debentures, derivative or units. These may be transferred/allotted directly or indirectly to the employee.
In case of ESOPs or Sweat Equity shares, liability to pay tax arises at two stages which are discussed below in detail :
Stage 1:Taxability as perquisites under the head Salary
When the shares/securities are allotted or transferred to the employee under ESOP or Sweat Equity shares, it is taxable as “perquisites under the income head Salary” in the assessment year relevant to the previous year in which such shares or securities were allotted or transferred. For this purpose, one has to find out fair market value of shares or securities on the date on which employee exercises the option.
Value of Perquisite chargeable under the head Income from Salary would be
- Fair market value as mentioned above minus amount actually paid or recovered from the employee in respect of such shares or securities.
Now let us discuss how to calculate the Fair Market value of shares which is a very important point.
- Where on the date of exercise of the option, the share in the company is listed on a recognized stock exchange in India, the fair market value shall be average of the opening price and closing price of the share on that date on the said stock exchange.
- Where, however, on the date of exercise of the option, the share is listed on more than one recognized stock exchanges, the fair market value shall be the average of opening price and closing price of the share on the recognized stock exchange which records the highest volume of trading in the share.
- Where on the date of exercise of the option, there is no trading in the share on any recognized stock exchange in India, the fair market value shall be the closing price of the share on any recognized stock exchange on a date closest to the date of exercise of the option and immediately preceding such date.
Important Note mentioned below ESOP :
“Closing price” of a share on a recognized stock exchange on a date shall be the price of the last settlement on such date on such stock exchange. Where the stock exchange quotes both “buy” and “sell” prices, the closing price shall be the “sell” price of the last settlement.
“Opening Price” of a share on a recognized stock exchange on a date shall be the price of the first settlement on such date on such stock exchange. Where the stock exchange quotes both “buy” and “sell” prices, the opening price shall be the “sell” price of the first settlement.
Where on the date of exercise of the option, the share in the company is not listed on a recognized stock exchange in India, the fair market value shall be such value of the share in the company as determined by a Merchant Banker on the specified date. “Specified Date” means the date of exercise of the option or any date earlier than the date of exercise of the option, not being a date which is more than 180 days earlier than the date of exercise of the option.
Income tax rates at Stage 1 : As the perquisite is chargeable under the head Income from Salary, individual slab rate structure will be applicable.
Computation of capital Gain on sale/transfer of stock option or sweat equity shares
Capital gains would be taxable in the year in which such shares/securities are transferred. Cost of acquisition would be fair market value on the date of exercise of option as discussed above at Stage 1.
Income Tax Rates at Stage 2 : If shares sold are equity shares listed on a recognized stock exchange, either long term capital gain or short term capital gain would arise. If it is a long term capital gain, special tax rate @10% u/s 112A of the Income Tax Act would be applicable. If long term capital gain does not exceeds Rs. 1 lacs, it is not chargeable to tax. If such gain exceeds Rs. 1 lacs, the amount in excess of Rs. 1 lacs will be taxable @ 10% (+surcharge + health and education cess). If tax is payable u/s 112A, cost of acquisition of equity shares shall be calculated according to the provisions of section 55(2)(ac). This provision is applicable only in respect of equity shares acquired by an assessee before 01.02.2018. No benefit of indexation is applicable.
If it is a short term capital gain, such gain is taxable at special rate of 15% (plus surcharge plus cess) u/s 111A.
If shares sold are unlisted equity shares. If it is a long term capital gain, capital gain would be taxable at the special rate of 20% u/s 112 of Income Tax Act. Cost of acquisition would be fair market value on the date of exercise of the option. If it is a short term capital gain, such gain would be taxable at individual income tax slab rates.
Also Read: Form 15CA and Form 15CB under Income Tax Act
Also Read: Liberalised Remittance Scheme (LRS) and Income Tax (TCS) implications on LRS
Also Read: Income tax on sale of equity shares or units of mutual funds – Section 112A
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