The government will review the taxation regime of employees’ stock ownership plans (ESOPs), the Economic Times reported. ESOP is a compensation tool for employees, especially in start-ups and this review will likely address the effectiveness of the instrument. The heart of the matter here is whether stock options should be taxed only when the employee sells them, and not again at time of vesting. If an employee sells the stock option, taxation as per capital gains will be levied. If the stock option is sold during the vesting period, the perquisite value gets added to the income and tax is levied according to the prevalent slab.

ET also reported that the review will not be confined to start-ups and said that the finance ministry had examined a proposal by the Department for Promotion of Industry and Internal Trade (DPIIT) on this issue before the Union Budget but the view was that the entire framework needed to be reviewed.

Taxation of ESOPs

As of now, ESOPs are subject to a two-stage taxation under the Income Tax Act, 1961:

  • Upon allotment of shares after the employee exercises his option on the completion of the vesting period: The difference between the Fair Market Value (FMV) of the shares on the date of exercise and the exercise/subscription price paid by the employee is taxable as perquisite under the head ‘Income from salary’ on the date of allotment of shares.
  • Upon allotment of shares to the employee: When the employee sells the shares, she/he will be taxed for capital gains. The capital gains is the difference between the sale proceeds and FMV of the shares that were already considered by the employer while computing the perquisite value. The employee can claim the expenditure that she/he may have incurred wholly in connection with the sale.