There is a lot a company needs to do for its employees. That is a clear obligation. Many organizations, particularly start-ups, have recently provided employee stock option plans (ESOPs) to their employees. Esops are growing more popular in India, with various local and foreign organizations providing them to their employees.
What is ESOP?
Employee stock ownership plans, which is the ESOP full form, provide employees with a stake in the company. In other words, Esops are the rights/options granted to eligible employees to purchase equity shares of the company at a predetermined pricing (usually face value) within a specified time frame (exercise period).
To grasp the notion, you should be familiar with a few basic phrases. The exercise date is the day on which the employee exercises the option to purchase shares. The vesting period is the time between the grant date and the vesting date.
The vesting date is where the employee becomes eligible to purchase shares after certain conditions are met. The grant date is the date where the employer and employee agreed to give the employees the opportunity to acquire shares (at a later date).
How Does ESOP Work?
Stock options are provided to qualifying employees under an ESOP, and such options may be exercised in the future to buy equity shares of the company at a predetermined exercise price. Such shares may be purchased if all of the plan’s conditions are met. The following are the broad procedure of an ESOP and the essential phrases pertinent to employees:
1) Drafting of an ESOP scheme or plan: The employer draughts the plan, which includes clauses such as plan administration, the role of the compensation committee in identifying eligible employees, option grant, vesting period, method of determining exercise price and period, eligible employees, and situations where options lapse due to resignation or termination of employees.
2) Board approvals and secretarial compliances: Employers must comply with appropriate compliances such as passing a board or shareholder resolution, as well as assuring compliance with the Securities Exchange Board of India standards in the case of a listed firm.
3) Option grants: Grant letters are sent to eligible workers that include the grant date, vesting details, exercise price, and other terms. This date is known as the “grant date.
4) Options vesting: The vesting period is the time between the date the option was granted and the date the employee became eligible to exercise the option. Vesting of options may differ from employee to employee depending on criteria such as length of service, employee performance, and other requirements specified in the plan.’
5) Option exercise: Once the vesting period is over, the employee has the right to exercise the option during the period stated for option exercise. The “exercise date” is the day on which the employee exercises the options. When the employee exercises the option, the company allows the shares to the qualifying employee in accordance with the ESOP. At this point, “options” are changed into “shares” of the corporation.
How are ESOPs Taxed on Liquidation?
Let’s get to the major part of this post and find out how ESOPs are taxed.
Many people are concerned about the tax consequences of liquidating ESOPs (ITRs). Because ESOPs are employee benefit plans, the proceeds from their liquidation are taxed as capital gains. The earnings from the difference between the share’s sales price and exercise price are taxed as either short – term or long – term capital gains, depending on how longthe period the shares were held.
Short-term capital gain: Taxpayers must compute the holding period from the date of the ESOP exercise to the date of sale. The earnings would be deemed short-term gains if sold within a year of the ESOPs being exercised. A short-term capital gain is determined at the standard tax slab rates under existing regulations under the Income Tax Act of 1961.
Long-term capital gain: Long-term capital gains are defined as shares or ESOPs held for more than a year. Long-term capital gains are taxed at 20% (for unlisted shares) or 10%. Long-term capital gains on listed shares are also tax-free, up to 1 lakh.
Listed and Unlisted Shares: The Income Tax Act distinguishes between listed and unlisted shares in terms of taxation. The tax treatment of shares that are not listed in India or are listed outside of India stays unchanged. For instance, if you own stock in an American corporation, your shares will not be listed in India.
In India, they may be regarded as unlisted for tax purposes. When held for less than three years, the shares are considered short-term, and when sold after three years, they are considered long-term. Beginning in the fiscal year 2016-17, UNLISTED equity shares will be classified as short-term capital assets if sold within 24 months of purchase and long-term capital assets if sold beyond 24 months [applicable for transactions made on or after April 1, 2016].
The holding period runs from the date of exercise to the date of sale. Short-term profits are taxed at income-tax slab rates, whereas long-term gains are taxed at 20% after cost indexation.
Residential Status: In India, your income is taxed based on your residency status. If you are a resident, all of your worldwide income is taxed in India. If you are a non-resident or resident but not a habitual resident and have exercised your options or sold your shares, you may be required to pay tax outside of India. In this instance, you may be eligible to use the Double Taxation Avoidance Agreement. It prevents your revenue from being taxed twice.
Non-Exercised Options: The employee acquires the opportunity to exercise his option or purchase the stock on the vesting date. Yet, there is no duty; the employee may choose not to exercise his option. There will be no tax implications for the employee in this scenario.
Disclosure: Numerous declarations for overseas assets have been added to income tax return forms. If you possess ESOPs or RSUs in a foreign company, you may be required to report your overseas interests on Schedule FA of your tax return. A resident taxpayer is subject to certain disclosure requirements.
Loss: If you have a loss, you can carry it forward in your tax return and modify and set it off against gains in future years if you have incurred one.
ESOPs have proven to be an effective method of giving long-term incentives to employees over the years. ESOP millionaires are a reality, and many start-up employees have benefited from this wealth-generating potential. As a result, it is critical for employees who receive ESOPs to understand the tax implications of exercising options and selling shares.
Conclusion
Why is it important to know the taxes on everything that comes your way? Knowing your taxes keeps you at the pinnacle of your financial life, makes you more stable, and gives you the ability to judge. That is why it’s also crucial to know the taxes on your ESOPS.
