Receiving ESOPs as Part of Your Salary?

ESOPs are becoming increasingly popular in India, especially as more multinational companies include them in employee compensation packages.

An Employee Stock Option Plan (ESOP) is a type of employee benefit program that provides workers with a stake in the company through equity shares. These plans are similar to profit-sharing schemes. Under an ESOP, the employer offers company shares to employees at a minimal or discounted price. These shares are held in an ESOP trust until the end of the vesting period, after which employees can choose to exercise their options—typically at the time of retirement or upon leaving the organization.

Important Terms Related to ESOPs

Before diving into how ESOPs and RSUs are taxed, it’s essential to understand a few important terms:

ESOP (Employee Stock Option Plan): A plan that allows employees to acquire ownership in the company by purchasing equity shares over a set period. The terms are mutually decided by the employer and the employee.
ESPP (Employee Stock Purchase Plan): This plan enables employees to buy company shares at a discounted rate. The payment is made directly through the employee’s bank account or is deducted monthly from their salary.
RSU (Restricted Stock Units): Typically offered by foreign-listed companies, RSUs are awarded to employees when specific milestones or performance targets are met. These are granted without any cost to the employee.
Grant Date: The date on which the employer and employee agree upon the right to purchase company shares at a later time.
Vesting Date: The date when the employee becomes eligible to purchase the shares, having met the agreed conditions. This is also considered the effective date of the grant.
Vesting Period: The time span between the grant date and the vesting date.
Exercise Period: Once shares have vested, employees are given a fixed duration to purchase them. This window is known as the exercise period.
Exercise Date: The specific date on which the employee chooses to exercise their option to purchase the shares.
Exercise Price: The agreed price at which the employee can buy the shares, usually set below the current market value. This price is determined on the grant date.

Once the employee completes the required service period or meets the necessary conditions, the stock options become vested. At this point, the employee may choose to purchase the shares during the exercise period at the pre-agreed exercise price. Since this price is often lower than the fair market value, it can offer a potential financial benefit. However, if the employee decides not to exercise the option, no shares are purchased and no tax liability arises.

How ESOPs Are Taxed

Taxation on ESOPs occurs at two different stages:

1. At the Time of Exercise – Treated as Perquisite Income

When an employee chooses to exercise their stock option (i.e., agrees to purchase the shares), the difference between the Fair Market Value (FMV) on the exercise date and the exercise price is considered a perquisite and taxed as part of salary income. The employer deducts TDS on this amount, and it reflects in the employee’s Form 16 and annual tax return.

Important Note:
From Financial Year 2020–21, employees receiving ESOPs from eligible start-ups get deferred taxation benefits. In such cases, the TDS on the perquisite is deferred to the earliest of the following:

Completion of 5 years from the end of the financial year in which the shares were allotted
Sale of the shares by the employee
Termination of employment

2. At the Time of Sale – Treated as Capital Gains

After exercising the ESOPs and acquiring the shares, if the employee sells them, it triggers a capital gains tax. The capital gain is the difference between the sale price and the FMV on the date of exercise.

Capital Gains Calculation:

Particulars	Amount
Sale Value	XXX
Less: Cost of Acquisition (FMV on Exercise Date)	XXX
Capital Gain	XXX

Illustration

Example:
Mr. Z, an employee at ABC Ltd., was granted 2,000 ESOPs at ₹80 per share on April 1, 2021.
He exercised his option on January 1, 2023, and later sold the shares in two parts:

First Sale (Short-term): October 1, 2023
Second Sale (Long-term): March 3, 2025

Event	Date	FMV (₹)	Exercise Price (₹)	Gain Per Share (₹)	Shares	Total Gain (₹)	Tax Payable
Exercise	Jan 1, 2023	150	80	70	2,000	₹1,40,000	₹14,000 (10%)
Sale (STCG)	Oct 1, 2023	175	150 (FMV)	25	2,000	₹50,000	₹7,500 (15%)
Sale (LTCG)	Mar 3, 2025	190	150 (FMV)	40	2,000	₹80,000	₹0*

*Note: LTCG is exempt up to ₹1 lakh per financial year. Gains above this are taxed at 10% without indexation.

How to Calculate Fair Market Value (FMV)

The Fair Market Value (FMV) refers to the market price of a company’s share on the date when the employee exercises their ESOP. This value is critical because, at the time of sale, the FMV on the exercise date is treated as the cost of acquisition for calculating capital gains.

Advance Tax on Capital Gains

Under the advance tax rules, individuals are required to estimate their total tax liability for the financial year and pay it in installments. While TDS is deducted when you exercise your stock options, you must also pay advance tax if you earn capital gains from selling those shares.

For FY 2023–24, the due dates for advance tax payments for individuals are:

15th June – 15% of total tax due
15th September – 45% of total tax due
15th December – 75% of total tax due
15th March – 100% of total tax due

If you delay or fail to pay advance tax, penal interest is levied under Sections 234B and 234C of the Income Tax Act. However, it is often difficult to predict capital gains in advance.

To address this, the tax law provides relief—no penal interest is charged for short payments in earlier installments if the shortfall is due to unexpected capital gains. However, the next available installment after the share sale must include the tax on those capital gains.

ax liability arises when you eventually sell these remaining shares, which is when capital gains tax applies.

2. Capital Gains and Losses

Tax on capital gains depends on how long the shares were held—from the exercise date to the sale date.

Listed equity shares sold after 12 months are treated as long-term capital gains (LTCG).
If sold within 12 months, they fall under short-term capital gains (STCG).

New Tax Rates (Effective 23rd July 2024):

LTCG (on listed shares): 12.5% without indexation (on gains exceeding ₹1.25 lakh)
STCG (on listed shares): 20%
STCG on other assets: Taxed as per applicable income tax slab rates

Revised Holding Periods (Budget 2024–25):

Asset Type	Holding Period for Long-Term Classification
Listed Securities	More than 12 months
Other Assets	More than 24 months

The earlier 36-month period for certain assets has now been removed.

If you incur capital losses, especially short-term ones, you can carry them forward in your tax return and offset them against future capital gains, reducing your future tax liability.

3. Listed vs Unlisted Shares

The Income Tax Act treats listed and unlisted shares differently for tax purposes. Shares that are not listed in India, including those listed on foreign exchanges (such as US companies), are generally treated as unlisted under Indian tax laws.

For taxation:

Prior to FY 2016–17, shares were considered short-term if sold within 3 years.
From 1st April 2016, unlisted equity shares are classified as:
- Short-term: Held for less than 24 months
- Long-term: Held for 24 months or more

The holding period is calculated from the date of exercise to the date of sale.

Short-term gains: Taxed as per applicable income tax slab rates
Long-term gains: Taxed at 20% with indexation benefits

Summary: Tax Implications on Sale of Shares

Type of Share	Holding Period (Before 23 July 2024)	Short-Term Tax Rate	Long-Term Tax Rate	Holding Period (After 23 July 2024)	Short-Term Tax Rate	Long-Term Tax Rate
Indian Listed Company	1 year	15%	10% (₹1 lakh exempt)	1 year	20%	12.5% (₹1.25 lakh exempt)
Indian Unlisted Company	2 years	As per slab	20% with indexation	2 years	As per slab	12.5% (no indexation)
Foreign Listed Company	2 years	As per slab	20% with indexation	2 years	As per slab	12.5% (no indexation)
Foreign Unlisted Company	2 years	As per slab	20% with indexation	2 years	As per slab	12.5% (no indexation)

4. Buyback of Stock Options

In certain cases, especially in Indian startups, companies may buy back stock options from employees before they are converted into equity. This is common when equity conversion is only allowed during liquidation events (such as IPOs or funding rounds).

Since these shares are illiquid, employers may choose to buy back the options directly to provide liquidity.

The amount received is treated as salary income, and TDS is deducted under Section 192. It is reported in Form 16 and doesn’t require separate disclosure in your ITR.

5. Residential Status

Your residential status plays a key role in determining your tax liability in India:

If you are a Resident, global income is taxable in India.
If you are a Non-Resident (NR) or Resident but Not Ordinarily Resident (RNOR), income from exercising options or selling shares outside India may not be taxable in India.

Hence, correctly assessing your residential status is essential.

6. Disclosures of Foreign Assets

If you hold foreign ESOPs or RSUs, and are classified as a resident, you are required to disclose such holdings under Schedule FA (Foreign Assets) in your Income Tax Return.

This includes:

Foreign stock options
Vested RSUs
Any foreign equity holdings

These disclosures are mandatory for resident taxpayers.

7. When Options Are Not Exercised

Upon vesting, employees gain the right to purchase shares, but it is not mandatory to exercise the option. If the employee chooses not to exercise, no tax is applicable as no income or benefit has been realized.

8. When Options Are Not Exercised

On the vesting date, an employee becomes eligible to exercise the stock option—that is, to purchase the allotted shares. However, there is no obligation to do so. The employee can choose not to exercise the option if, for example, the current market price is lower than the exercise price or for personal financial reasons.

In such a situation, since the option is not exercised and no shares are acquired, there is no income or benefit realized. Therefore, no tax is applicable.

Frequently Asked Questions (FAQs)

1. Do I have to pay tax if I don’t exercise my ESOPs?
No. If you choose not to exercise your ESOPs, there is no income or benefit, so no tax liability arises.

2. Will the unexercised ESOPs still appear in my Form 16 or ITR?
No. Only exercised ESOPs where a perquisite value has been created will appear in Form 16 and need to be reported in the Income Tax Return (ITR).

3. Can I defer exercising my ESOPs after the vesting date?
Yes, you can defer exercising as long as it’s within the exercise period defined by your employer. After this period expires, the options may lapse.

4. What happens to my ESOPs if I leave the company without exercising them?
If you leave the organization without exercising your vested options, you may lose the right to exercise them unless your company allows post-exit exercise within a specified period.

5. Are there any penalties for not exercising vested ESOPs?
No, there are no tax penalties or charges. However, the options may lapse as per the company’s ESOP policy, resulting in a loss of potential ownership.