All about ESOP and its taxability

Guide to ESOP with taxability

In this post, we’ll talk about ESOP, including its taxability, benefits and other important points. Where we will take a close look at each section in detail:

What are ESOPs?

Employee stock ownership plans, or ESOPs, are a method by which a business enables its staff to buy the company’s shares. ESOPs are also known as employee stock option plans in India. In some situations, a foreign holding firm offers this choice to the staff of an Indian subsidiary.

Employees are given options, which allow them to purchase stock at a discount from its current market value, or they receive a certain percentage of their pay in the form of company shares.

Some key terms you must know

In order to understand the concept, you need to be familiar with a few basic terms. When an employee exercises his or her option to buy shares, that is the exercise date. 

An employee’s vesting period begins on the date of grant and ends on the date of vesting.

After the earlier conditions are met, the vesting date is the date the employee can purchase shares.

The grant date refers to the date when the employer and employees agree that employees will be able to own shares in the company.

ESOP is more like a profit-sharing plan. Under these plans, the company or the employer offers its stocks, typically, at low or negligible prices. In most cases, (employees) exercise the options when they retire/leave the company, and the stock remains in an ESOP Trust Fund until the vesting period.

Benefits of ESOPs to employers and employees

Purchasing a departing owner’s shares: Private company owners may sell their shares through the ESOP. Companies are permitted to make tax-deductible donations to the ESOP in order to purchase their shares, or they can borrow funds through the ESOP in order to purchase their shares.

Lower after-tax cost of borrowing money: ESOP cash is borrowed and used to purchase firm and existing owner shares. Contributions to the ESOP that are made to pay back the loan amount are tax deductible. Interest and principal are both tax deductible.

Creates a benefit for the workers: Treasury shares or new shares can be issued by a firm to an ESOP, and the value can be subtracted from taxable income. Companies will sometimes pay the ESOP cash to purchase shares from current public or private owners.ESOPs and employee savings plans are combined in public corporations. Employers have the option of matching employee savings through stocks from an ESOP rather than cash, and normally, they will match the contributions at a higher amount through stocks.

Tax implications of ESOPs or Calculating Taxes

  • Options given by the firm are not subject to taxes.
  • Options that have vested are not taxed.
  • According to the employee’s tax bracket, the difference between the market value of the shares and the exercise value will be taxable when the employee try to buy shares.
  • The sale of the shares by the employee is considered a capital gain. If the employee sells the shares within one year, the capital gain is taxed at 15%.
  • When the employee sells off the shares after a year, they are taken as long-term assets and are not taxable.
  • Employees with ESOPs in a foreign company will have short-term capital gains when they sell their shares, which will be added to their income. After that, the employee will be taxed according to the tax bracket that applies to him or her.
  • The long-term capital gain tax rate is 10% without indexation or 20% with indexation.

Issues with ESOP

  • The company’s options can turn into responsibilities. Since there is no option premium in ESOPs, the only compensation a firm may expect to receive is indirect—increased liquidity and occasionally a tax benefit. As with regular stocks, there is no change in the exercise’s risk. Due to this, options may contain high risk than normal stocks.
  • Liquidity is generated only when the options are exercised, and the amount of liquidity is uncertain until the date of exercise. The liquidity benefits of ESOPs are more uncertain. 
  • Valuation and accounting guidelines for ESOPs are still unclear in many companies.

Other considerations

To properly calculate tax on the sale of ESOPs certain aspects need to be kept in mind.

Short-term or long-term gains

Your holding time will determine the tax rates that apply to your capital gains. The holding period starts with the exercise date and ends with the sale date. If held for more than one year, equity shares listed on a recognised stock exchange (where STT is paid on sale) are considered long-term gains. Suppose if sold within a year, then they are considered short-term gains. On LTCG above Rs 1 lakh, long-term capital gains on listed equity shares are taxed at 10% without indexation, while short-term capital gains are taxed at 15%.

When you have incurred a loss

Suppose if you have incurred a loss, you can carry it forward and adjust & set it off against future gains in your tax return.

Listed or unlisted shares

According to the Income Tax Act, listed and unlisted shares are taxed differently. Shares that are not listed in India or that are listed outside of India continue to receive the same tax treatment. In other words, if you own shares of an American company, they won’t be listed in India. For taxation purposes in India, they can be regarded as unlisted. The shares are long-term when sold after 3 years and short-term when held for less than 3 years. Starting FY 2016-17, UNLISTED equity shares shall be short-term capital assets – when sold within 24 months of holding them and long-term capital assets – when sold after 24 months of holding them [Applicable for sales made on or after 1st April 2016].

From the date of exercise until the date of sale, the holding period begins. In this situation, Short-term gains are taxed at income-tax slab rates, while long-term gains are taxed at 20% after indexation.

Residential status

In India, your taxable income is determined by your residential status. If you live abroad, India will tax every dollar of your worldwide income. However, if you exercised your options or sold your shares as a non-resident or a resident but not normally resident, you might need to pay tax outside of India.  In this situation, you might be able to profit from a double taxation avoidance agreement (DTAA). It ensures that your revenue is not taxed more than once.


For foreign assets, a number of disclosures have been included in income tax return forms. You may need to report your foreign holdings under schedule FA of your income tax return if you own ESOPs or RSUs of a foreign company. Any taxpayer who is a resident is subject to these disclosure requirements.

When options are not exercised

The employee gains the right to exercise his option or purchase the stocks on the vesting date. However, there is no obligation, and the employee is free to decide not to use his option. In such a case there shall be no tax implication for the employee.

This post about ESOP has come to an end. Share your views and opinions with us in the comment section below.