Employee Stock Option Plan – All you need to know

This document covers

1. Types of ESOP's.
2. Terms to Understand.
3. Taxation of Stock Option Plans in the hands of Employee.
4. Rate of Tax on Capital gains.

1. Types of ESOP's

There are various types of Employee Stock Options available

1. Employee Stock Option Plan (ESOP) : It is a right offered by a company to its employees to take equity shares of a company at a discounted price.
2. Employee Stock Purchase Plan (ESPP) : It allows employee to purchase company's shares, often at a discount from Fair Market Value (FMV) at the quarter-end.
3. Restricted Stock Unit (RSU) : Employee is awarded with the shares subject to fulfilment of certain underlying conditions. The underlying conditions would be like Target, Revenue, Performance based
4. Stock Appreciation Rights (Cash Settled and Equity Settled) : Employee gets the benefit in the form of cash / equity which is the difference between the date of grant and final exercise (aka execution) of options

2. Terms to Understand

There are few term which you need to understand before understanding the Tax impact

1. Grant : Grant of the Option means giving an option to the employee to subscribe the shares of company.
2. Grant Date : The date of agreement between the employer and employee to give an option to employee to own shares.
3. Vesting : It is the process through which employee becomes eligible to exercise options
4. Vesting Date : The date the employee is entitled to buy shares, after conditions agreed upon earlier are fulfilled. This date will be agreed upon grant date itself.
5. Exercise Period : Once the stocks have vested, the employee will have right to buy the shares for a period of time. This period is called exercise period
6. Exercise Date : The date on which employee exercises (employee applies to company for getting shares allotted) the option is called exercise date
7. Exercise Price : The Price at which employee exercises (buys) the stock is called exercise price. Generally the price will be lower than fair market value depending on the stock option type

3. Taxation of Stock Option Plans in the hands of Employee

Stock Option Plans involves taxation at 2 stages i.e., at the time of exercise and at the time of Sale.

1. At the time of Exercise : When the stock options are exercised by the employee, the difference between fair market value on the date of exercise and exercise price paid by employee will be considered as perquisite and taxable under the head Income from Salary

For Example : Mr Krishna, Employee of MNC exercises 1000 shares @ Rs 10 per share on 03rd Feb 2021. The Fair market value of shares as on 03rd Feb 2021 is Rs 100 per share.

Here, Perquisite Value is (1000 shares *100) – (1000 shares*10) = Rs.90,000

Rs 90,000 will be added as perquisite value and taxable under the head Salaries. It will be taxed as per Mr Krishna Slab rates.



2. At the time of Sale of Shares : When the stock options are sold at future date, the employee needs to pay capital gains tax in the year of Sale.

For Example: Mr Krishna sold his shares on 15th Feb 2022 @ Rs 200 per share. Then the capital gains calculation is as follows

Sale Value : 1000 shares * 200 per share = Rs 2,00,000
Purchase Value : It will be Fair market value as on date of exercise: 1000 shares* 100 per share = Rs. 1,00,000
Capital Gain is Sale Value - Purchase Value = 2,00,000 - 1,00,000 = Rs 1,00,000

4. Rate of Tax on Capital gains

1. If the Stock is unlisted and the employee holds for 2 years and more, the Capital Gain tax rate is 20% and the employee can claim Indexation benefit
2. If the Stock is unlisted and the employee holds for Less than 2 years, Capital Gain tax rate is Slab rate of employee.
3. If the Stock is listed and the employee hold for 1 years and more, Capital Gain tax rate is 10%
4. If the Stock is listed and the employee hold for less than 1 year, Capital Gain tax rate is 15%

NOTE: Budget 2024 has announced Significant changes in taxation of long Term capital Gains and Short term capital Gains. Below table summarizes the long term capital gain taxation and short term capital gain taxation on stock options