Do you also get fascinated by the term ESOPs as we do?? Well, if your reply is YES then this article is what you need to understand almost everything about Employee Stock Ownership Plans i.e., ESOPs. Today, we are going to explain everything you need to know regarding ESOP, from its accounting to taxability. In this article, you will find answers to the following key questions related to ESOP:-
● What is an ESOP?
● How does the ESOP cycle work?
● How is ESOP accounting done?
● Are ESOP expenses allowed as a deduction to employers while filing Income Tax returns?
● What are the tax implications of ESOP in the hands of an employee?
● How to calculate the FMV of ESOP for income tax calculation?
● Is TDS deductible on ESOP granted to employees?
● Is any relief given with regard to ESOP taxability?
So, without further ado. Let’s get started and get all your doubts cleared about ESOPs. Happy reading!!
What is an ESOP?
An Employee Stock Option Plan (ESOP) is an employee benefit plan given to employees by employers, which enables employees to own a stake in the company they work for. It is one of the most lucrative plans used by companies, especially startups to retain talent. ESOPs are also attractive financing tool options for companies who want to raise funds but don’t want to initial public offering.
How does the ESOP cycle work?
ESOP Cycle has different stages, which are:-
➔ Grant of options – At this stage, the company offers a specified no. of shares to employees under the ESOPs benefit scheme. The date when such an option is provided is called the date of grant.
➔ Vesting Period – Once shares are offered the vesting period starts. During this period ESOP remains in an ESOP trust fund set up by the company for a specified period.
➔ Exercise Period – Once the vesting period expires, the employees get the right to exercise their option. The date on which the employees choose to do so is called the exercise date.
➔ Allotment/Sale – After the employees exercised their options, shares are allotted to them at a discounted price.
How is ESOP accounting done?
In India, ESOP accounting is done on the basis of the following:-
➢ Guidance Note (Issued by ICAI) – According to which there are two accounting methods for ESOPs. One is the Fair Value Method which is recommended in Guidance Note and the Intrinsic Value Method other is which also can be followed.
➔ For the purpose of ESOP accounting valuation, the Intrinsic value is defined as the excess of the current market price of the share under ESOP over the exercise price of the option (including upfront payment, if any) i.e.,
Intrinsic Value = Current Market Price – Exercise Price
Under the fair value method, which is recommended by ICAI through Guidance Note, ESOP value is estimated using an option-pricing model like the Black-Scholes or a binomial model. These models take into account various other factors such as exercise price, the life of the ESOP cycle, time value, interest rate, volatility, and dividend yield.
As per Ind AS 102 (Share-Based Payments), accounting of ESOP is done by the company at the time of grant & subsequent period by recognizing the amount for the service received during the vesting period based upon the number of shares expected to vest i.e.,
No. of Shares *Option Price*
No. of employees to whom shares expected to vest
Are ESOP expenses allowed as a deduction to employers while filing Income Tax returns?
Companies while offering ESOP bear huge expenses as ESOPs are usually offered at discounted rates to employees. Therefore, companies want to take a deduction for ESOP expenses to nullify the impact of cost on their profits.
Although, the Income Tax Act, 1961 does not provide any section related to ESOP expense deduction in the hands of the employer. But it has always been discussed in detail in the courthouses and generally, in most litigation cases, the court has ruled that ESOP expenses are allowed as deduction as a general expense under Section 37 of the Income Tax Act, 1961.
Section 37 grants deduction for expenses that are neither personal nor capital in nature i.e, business revenue expenditure, and are not specifically under Section 30 to Section 36.
What are the tax implications of ESOP in the hands of an employee?
As per the Income Tax Act, 1961, ESOPs are taxed in hands of an employee at two instances, which are:-
➔ Firstly, when an employee exercises his ESOP option and shares are allotted to him by his company, ESOPs are taxable as part of his salary income. Here, the taxable amount shall be calculated as below:-
FMV of shares on the date on which option exercised
– Amount paid by Employee for ESOPs
➔ Secondly, ESOP is taxed under capital gain income in the hands of an employee when he sells those shares allotted to you under the ESOP scheme. Capital gains shall be calculated as below:-
Full value of consideration i.e, Sale Value
– Cost of Acquisition i.e, FMV of Shares
Period of holding shall be considered from the date of allotment of ESOPs till the date of transfer of shares by an employee.
How to calculate the FMV of ESOP for income tax calculation?
For the purpose of income tax calculation, the FMV of ESOPs shall be calculated as per rule 3(8), which says:-
In the case of Listed Shares
● If traded on one recognized stock exchange on the date of exercise – FMV shall be the average of opening and closing price of the share on the said stock exchange.
● If traded on more than one stock exchange on the date of exercise – FMV shall be the average of opening price and closing price of the share on the recognized stock exchange which records the highest volume of trading.
● If shares are listed on one recognized stock exchange but not traded on the date of exercise – FMV shall be the closing price on the date preceding the date of exercise.
● If shares are listed on more than one recognized stock exchange, but not traded on any of it on the date of exercise – FMV shall be the closing price of the share on the recognized stock exchange which records the highest volume of trading on the date preceding the date of exercise.
In the case of Unlisted Shares
● In case on the date of exercise, the share is not listed on any recognized stock exchange – FMV shall be determined by a merchant banker on the specified date.
Is TDS deductible on ESOP granted to employees?
Yes, when you exercise your option, the employer has to deduct TDS on ESOPs which forms a part of your salary as perquisite. This amount is shown in the employee’s Form 16 and included as part of your total income from salary in the tax return.
Is any relief given with regard to ESOP taxability?
As we all know Start-up companies are heavily dependent on ESOPs for retaining talent, therefore relief has been given to employees of “eligible startups” by the government with regard to TDS deduction on ESOPs.
As per Finance Act 2020, w.e.f AY 2021-22, an employee receiving ESOPs from an eligible start-up need not pay tax in the year of exercising the option. In this case, an eligible startup requires to deduct TDS on the ESOPs within the fourteen days, from:-
➔ Expiry of 48 months from the end of relevant AY i.e., the year of allotment of ESOPs.
➔ Date of sale of the ESOPs by the employee.
➔ Date of termination of employment.
Whichever is the earliest, on the basis of rates in force for the financial year in which ESOP is allotted to employees.
Hope, all your doubts related to ESOP are cleared through this article. If you need any further professional guidance.
