Finance ministry may look into taxation of employee stock ownership plans

NEW DELHI: India will review the taxation of employee stock ownership plans (Esops) to address issues that curb their effectiveness as a compensation tool, said a senior finance ministry official. This review will not be confined to startups, he added.

A proposal by the Department for Promotion of Industry and Internal Trade (DPIIT) had been examined by the finance ministry in the run-up to the budget but the view was that the entire framework needed to be reviewed, and not just for startups.

A key issue is whether stock options should be taxed only when an employee sells them and not again at the time of vesting. There are also issues with the valuation of the benefit in the case of unlisted companies. “The issues around Esops have to be examined in entirety…The issue is on the table,” the official said. “We will look at all practices followed and pros and cons from investor, tax department and industry point of view.”


Stock options and other such instruments are a popular compensation tool for the industry, particularly startups. Companies also use them to retain talent. The DPIIT had pushed for making Esops in startups taxable only at the time of sale.

Another official said there was a need to study the prevalent structures before any change is made in the tax regime.

POPULAR LONG-TERM INCENTIVE PLANS
Four types of long-term incentive schemes are in vogue. Most popular are Esops under which options are granted to the employees at a predetermined, generally discounted, price, with vesting conditions attached. Others are restricted stock units (RSUs), employee share purchase plans (ESPPs) and stock appreciation rights (SARs). RSUs come with an entitlement to receive one share against each one allotted, subject to vesting conditions. Under ESPPs, shares are allotted immediately, on the date of grant, at a discounted or market rate. A lock-in period may be imposed as a retention strategy under this scheme.

SARs or phantom units entail the grant of notional shares, implying that employees are not allotted actual shares. Once vesting conditions are met, the employees are paid the differential between fair market value and the grant price in cash.

TAXATION
Under the Income Tax Act, 1961, the taxation of Esops is prescribed in two stages. First as a perquisite and second as capital gain.

When the option is exercised after the vesting period is over, the perquisite value will be added to income and taxed at the slab rate. This perquisite value is the difference between fair market value of the share and the exercise price. This would be applicable in the case of Esops, RSUs and ESPPs. In the case of RSUs, the cash paid to the employee is taxable as salary.

When the allotted shares are sold by the employee, the capital gain will be the sale price minus the fair market value considered earlier. It will be taxed depending on the period for which it has been held.