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Taxation of Employee Stock Option Plan (ESOP) || Direct Buy-Back of ESOPS - Is it Loophole That Can Be Explored To Save Tax ?




What are ESOPS

ESOPs i.e. Employee Stock Option Plan, are provided by employers to employees generally to retain top talent. It acts as a motivational tool making employees responsible for the growth and performance of the company as personal benefit is attached to it in form of ESOPS. ESOPs are more popular among start-ups may not able to pay high salaries in initial days to employees. ESOPs allows to employment highly talented employees at a relatively low salary amount with the balance being ESOPs.


Taxation of ESOPS

ESOPS are generally offered to employees at face value or concessional rates, thus this indirect benefit transferred to employees is taxable as perquisites. ESOPS Tax arise in two instance :


A. At time of allotment of ESOPS:

When an employee exercises the option, the difference between the Fair Market Value (FMV) of the securities on the date of exercising of option and the amount paid by the employee for such securities, is taxable as perquisite.


The fair market value of the following securities allotted under the ESOP scheme shall be computed as per Rule 3: a) Quoted shares; and b) Unquoted equity shares.

Scenarios

FMV

​Listed Shares

​Average of the opening price and closing price of the share on that date on the stock exchange

​Shares Listed on Multiple Stock Exchange

​Average of opening price and closing price of the share on that stock exchange which records the highest volume of trading in the share

​Unlisted Shares

Value of share as determined by a merchant banker on:  The date of exercising of ESOP; or  Any date earlier than the date of the exercising of the option, not being a date which is more than 180 days earlier than the date of the exercising.

B. At the time of transfer of shares by the employee


Securities when transferred subsequently by employees than the gains arising therefrom shall be taxable under the head 'Capital Gains'.


The taxability of capital gains shall depend on the type of security and the period of holding thereof. The period of holding of securities shall be the period commencing from the date of allotment of securities, and not from the date of exercising of option, ending on the date when employees transfer the securities.


Fair Market Value of Securities on which tax is paid as perquisite income will be considered as cost of aquisition.


Following will be tax rates payable on basis of type of securities and period of holding :


1. Listed Equity Shares - Hold For More than 12 Months - 10% plus surcharge plus cess

2. Listed Equity Shares - Hold For Less than 12 Months - 15% plus surcharge plus cess

3. UnListed Equity Shares - Hold For More than 24 Months - 30% plus surcharge plus cess

4. UnListed Equity Shares - Hold For More than 24 Months - 20% plus surcharge plus cess

5. Anyother Form of Securties - Long Term - 20% plus surcharge plus cess

6. Anyother Form of Securties - Short Term - 30% plus surcharge plus cess


C. Additional Tax Benefit in Case of Long Term Capital Gain:


In case period of holding results in long term capital gain than employees can claim benefit of

  1. Indexation of Cost of Aquisition

  2. Deduction u/s 54F by purchase of new residential house property


Date of Tax Liability Arises on ESOPS

Tax Liability to deduct or payment tax on ESOPS arises when securities are alloted to them. But if the company is eligible startup under Section 80-IAC than the liability of payment or deduction of tax on such perquisite will be deferred and arise earlier of below three events :

a) On the expiry of 48 months from the end of the assessment year in which securities are allotted under ESOPs;

b) From the date the assessee ceases to be an employee of the organization; or

c) From the date of sale of securities allotted under ESOP.



Buy Back / Cancellations of ESOPS - One of the Method to Save ESOP Tax

There are various divergent views within the tax professionals that if without alloting the ESOPS , if those are buy back / cancelled by the company than it may be directly subject to long-term capital gain if options were held for more than 24 / 36 months as per type of securities .


This may result in avoiding reducing the effective tax rate from 30% under head of salary to 20% under long term capital gain . Further, there employees can also save tax by claiming 54F deduction on whole consideration of esops amount by buying new residential house.


Relevant case law suggesting above mechanism - N.R. Ravikrishnan v ACIT [IT APPEAL NO. 2348 (BANG.) OF 2018 dated 31.10.2018] (Bangalore ITAT)


Note : Above view can be litigative in nature and may require analysis of facts , circumstances and relevant tax advice from professional


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