oining a firm where part of the package is the lucrative employee stock options?
This is a common bait dangled at those joining software companies.
Here's what an ESOP is and the tax implications of it.
1. What are ESOPs?An Employee Stock Option Plan is when the company offers its shares to the employees.
An ESOP is nothing but an option to buy the company's share at a certain price. This could either be at the market price (price of the share currently listed on the stock exchange), or at a preferential price (price lower than the current market price).
If the firm has not yet gone public (shares are not listed on any stock exchange), it could be at whatever price the management fixes it at.
2. Why would a company offer an ESOP?
Let's first explain what owning a share entails.
When you invest in shares, you do not invest in the market. You invest in the equity shares of a company. That makes you a shareholder or part owner in the company.
Owning an equity share means owning a share in the company business.
Companies offer their employees shares because it is considered that having a stake in the company would increase loyalty and motivation substantially.
3. When are they given?
It depends on company policy and your designation.
There are time limits for availing this scheme. For instance, you can acquire the shares after you complete a particular period of employment. This could be a year, even longer.
This is known as the vesting period, and generally ranges from one to five years.
If you quit your job before this period is complete, the stock options lapse.
Sometimes, the ESOPs are given in a phased out fashion -- 20% in the second year, another 20% in the third year, etc.
4. When are they taxed?
The ESOP is not taxed on acquiring the shares.
You are taxed on the profit you make when you sell the shares or transfer them.
Transfer here refers to when you gift it to someone or transfer it to someone else under an irrevocable deed (they now own it, not you).
5. How are they taxed?
When you sell any asset you own (house, land, shares, mutual fund units, gold, debentures, bonds), and you make a profit on the sale, it is known as capital gain.
The tax you pay on this profit is called the capital gains tax.
Capital gains tax is computed on the difference between the sale price and the issue price (the price at which shares are offered to you).
If you sell the shares within a year of allotment (within 12 months of acquiring them), it is a short-term capital gain.
If you sell the shares after a year of allotment (after 12 months of acquiring them), it is a long -term capital gain.
6. What if they are listed abroad and sold abroad?
This depends on whether you are a resident or non-resident Indian.
If you are a non-resident, it will not be taxable, as the gains occur outside India, unless the money is received in India.
If you are a resident in India, then you will be taxed on the gains.
Long-term capital gain is taxed at 20%.
Short-term capital gain is added to your overall income and taxed according to your slab rate.
7. What if they are listed and sold in India?
The taxability depends on the nature of gain at the time of sale.
If you have a short-term capital gain, you have to pay tax at the rate of 10% (plus surcharge if applicable).
Long-term gains are exempt from tax.
8. Do I have to pay a security transaction tax if sold in India or abroad?
If you sell your shares on or after October 1, 2004, you need to pay the Securities Transaction Tax in India.
Also the STT is leviable in abroad as per their rules.
9. Can I avail of indexation?
You use indexation when you calculate tax taking into account the inflation. This is good because it reduces the amount of capital gain and the amount you end up paying as tax. To read more about indexation, read All about capital gains.
Indexation is available only for long-term capital gains. Since the long-term capital gains on shares and options are not taxable now, it is not required.
10. Can I invest the profit to avoid tax?
Long-term capital gain on shares are exempt, so this does not arise.
There is no provision to invest the short-term capital gains to avoid tax.
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