Here's how Flipkart employees' ESOPs will be taxed
The money that Flipkart employees are now expected to make from ESOPs has caught the limelight. Here's a lowdown on how ESOPs are taxed in India.
Post the Flipkart-Walmart mega deal, the money that Flipkart employees are expected to make from ESOPs has caught the limelight.
But don't forget that the taxman often gets a bite out of most income. So here's a lowdown on how ESOPs are taxed in India.
As per Income Tax Act, 1961, the ESOP allotted to employees are taxed at two stages described as below:
1. When the employee exercises the option to buy the shares on completion of vesting period i.e. upon allotment.
2. When the shares allotted are sold by the employees.
Let us discuss the tax implication under both these stages:
1. Under the first stage, the difference between the exercise price and the fair market value of ESOP is treated as perquisite under the head income from salary. In such case, the employer shall compute the perquisite value of ESOP taxable in the hands of the employee and deduct tax thereon. It shall be reflected in Form 16 And Form 12BA of the employee.
Perquisite value = FMV per share - Exercise price per share x number of shares allotted.
2. Now, under the second stage, the transaction of sale will attract capital gains tax. It can be either long term capital gains tax or short term capital gains tax, depending on the holding period of such ESOP-shares. The holding period in case of such ESOP-share will start from the date of allotment of the share. The holding period is different for listed shares and unlisted shares.
For listed shares the holding period is treated as long term if the shares are held for more than one year. Whereas for unlisted shares the time period to qualify as long term holding period is two years as per the changes in Budget.
It is to be noted that for the purpose of computing capital gain, the fair market value as on the date of exercise, which was considered as perquisite when the ESOP-shares were allotted shall be treated as the cost of acquisition (COA) and not the actual price paid by the employee.
Therefore, Capital gain = Sale Amount - FMV at the time of exercise of option
Now, Let's move on to the taxability under STCG or LTCG.
1. If ESOP-shares are hold for Long term
As per Finance Act 2018, if the shares are traded on stock exchange, then the long term capital gains shall be taxed u/s 112A at 10% exceeding Rs 1 lakh of capital gains. However, if the shares are not traded on recognised stock exchange, then the LTCG shall be taxed @ 20% with the benefit of indexation.
2. If ESOP-shares are held for Short term
If the shares are traded on stock exchange are sold then in such case, the short-term capital gains shall be taxed at a flat rate of 15% under Section 111A. However, if the shares are not traded on recognised stock exchange, then the short capital gain shall be treated as just like any other income and shall be taxable as per the applicable slab rate.
Now, we shall discuss the situation when ESOP-shares are bought back by the Company.
When it comes to a buyback of shares of an unlisted company, then provisions under sections 10(34A) and 115QA of the Income Tax Act shall intervene.
As per section 10(34A), any income arising to a shareholder (including ESOP-shares) on account of buy back of unlisted shares by the company shall be exempt in the hands of such shareholder. Further, as per section 115QA, the tax @ 20% shall be paid by the unlisted company on the buyback of its shares.
Therefore, in the hands of the employees, the gain from the buyback of shares by an unlisted company shall be exempt and the company shall be liable to pay buyback distribution tax.
It is to be noted that if the employee sells ESOP-shares to a third party instead of the company, then he shall be liable to pay capital gain tax and the company need not pay any taxes, as the transaction happened between an employee and the purchaser.
(Tax2win is a tax return filing website.)