ESOP Taxation in India: Navigating

FEMA and Startup Regulations

WHAT ? WHY ?

An Employee Stock Option ESOPs are typically offered by

Plan (ESOP) is a program that employers as a means to
allows employees to buy reward employees and retain
shares of the company at a top talent. They serve as a
discounted price after a motivational tool, fostering a
certain vesting period. It is sense of ownership among
implemented to motivate employees and encouraging
employees, align their goals them to contribute to the
with the company’s success, company’s success. ESOPs
and enhance talent retention. allow start-ups to employ
It is taxable as a perquisite in highly talented employees at a
the year in which the relatively low salary amount
securities have been allotted with the balance being made
to the employee. up via ESOPs.
Tax implications of ESOPs in hands
of Employees

Taxation
Event Details
Type
• At the time of allotment, tax is
deducted at the average rate of tax
when the salary is paid.

• Perquisite value is the difference

between the FMV (Fair Market Value) at
1. Allotment Perquisite the time of exercising and the amount
of Shares Taxation paid by the employee.

• FMV is determined as per Rule 3

.
• The FMV at the time of allotment is not
relevant for perquisite value
calculation

• Gains arising from the transfer of ESOP

shares are taxable under Capital Gains
.
• The period of holding is calculated from
2. Transfer Capital the allotment date (not the date of
of Shares by Gains exercise) to the date of transfer.
Employee Taxation
• The FMV at the time of exercising the
option is used as the cost of
acquisition to calculate the capital
gains.

Employers providing ESOPs can claim deductions for

ESOP-related expenses, as these are considered
employee compensation costs. This treatment is
supported by various court rulings, which have upheld
such expenses as allowable deductions under
Section 37 of the Income Tax Act
Scenario for better Understanding

ABC India Private Limited granted ESOP to Mr. B

on 01-04-2020 with a vesting period from 01-
04-2020 to 31-03-2022. Mr. B exercised 100
ESOPs on 10-05-2022, when the Fair Market
Value (FMV) was Rs. 6,500 and Rs. 6,000 on
31-03-2022 respectively. The exercise price was Rs. 500 per
share. Suppose Mr. B sold 40% shares on 31-12-2022 when FMV
was Rs.7000 and 60% shares on 13-09-2024 when FMV was
Rs.8000. Calculate the perquisite value of the ESOPs exercised.

• Tax Implications on Allotment

• Perquisite Value = (FMV on exercise date − Exercise
P Price) × Number of ESOPs
= (6500 – 500) * 100
= Rs 6,00,000
• Tax Implications on Sale
• Short term Capital Gains for 40% shares i.e. 40
shares sold on 15-12-2022:

Sale Price (31-12-2022): Rs. 7,000 per share

Cost of Acquisition (FMV on Exercise Date): Rs.
6,500 per share

Capital Gain = (Sale Price – Cost of Acquisition) ×

No. of shares sold
= (7,000−6,500)×40 = 500×40
= Rs. 20,000
• Long term Capital Gains on sale of 60% Shares i.e.
60 shares on 13-09-2024:

Sale Price (15-06-2024): Rs. 8,000 per share

Cost of Acquisition : Rs. 6,500 per share (FMV on
Exercise date)
Capital Gain = (Sale Price – Cost of Acquisition) ×
No. of shares sold
= (8,000 − 6,500) × 60
= 1,500×60 = Rs. 90,000
Taxation of ESOPs in Eligible Start-ups

The taxability of ESOPs for employees occurs in two stages: first,

when the securities are allotted to them, and second, when the
securities are sold as outlined in the previous scenario.

However, to ease the tax burden for start-ups, provisions like

Section 192, 140A, 191, and 156 have been amended to defer
tax on ESOP perquisites. Only eligible start-ups under Section
80-IAC and their employees qualify for this deferral.

Under Section 192, an eligible start-up must deduct tax on

perquisites from ESOPs within 14 days of the earlier of the
following events:

48 months from the end of the assessment

1 year in which securities are allotted;

2 The date of sale of the securities

The date the employee leaves the

3 organization;

The tax will be based on the rates for the financial year of
allotment or transfer. Employees must disclose the ESOP
perquisite value in their return but won't pay tax on it in
that year.

The tax payable on salary, excluding the ESOP perquisite,

will be calculated as per the formula provided:

(Income
excluding
Tax on Tax on Total
ESOPs)/
salary Income
(Total
(excluding (including
Income
ESOPs) ESOPs)
including
ESOPs)
Scenarios for better Understanding

Mr. A, working in an eligible start-up company, has been

allotted 100,000 shares at the rate of Rs. 10 per share under
the ESOP scheme in the Financial Year 2022-23. The fair
market value of shares at the time of exercising of option by
Mr. A is Rs. 100. The perquisite value of ESOPs taxable in the
hands of Mr. A shall be Rs. 90 Lakhs [100,000 shares* (Rs. 100
– Rs. 10)]. The annual salary of Mr. A (excluding perquisite value of ESOPs) in
that year is Rs. 40 Lakhs. He continues with the company even after the
expiry of 48 months from the end of the assessment year in which shares are
allotted and he does not sell the shares even after the expiry of said period.
What shall be the mechanism for deferment of TDS and tax on the perquisite
value of ESOPs in such a case?

Assessment Year 2023-24

Mr. A must disclose the perquisite value of ESOPs (Rs. 90 lakhs) in his return of
income but he shall not be liable to pay any tax thereon in the year of allotment
of shares. The tax to be paid shall be computed as below:

Particulars Amount (in Rs.)

Total Income before ESOP perquisite (A) 40,00,000
Total taxable income after incl. perquisite value of
Rs.90,00,000 (B) 1,30,00,000
Tax on Total Income including surcharge(15%) and
44,40,150
cess (4%) (C)
Tax liability attributable to salary income (excluding
13,66,200
the perquisite of ESOPs) [C * A/B]

Assessment Year 2027-28

If Mr. A continues with the company after the expiry of 48 months from the
end of the AY in which shares are allotted and does not sell the shares even
after the expiry of said period, the tax liability on perquisite value of ESOP will
arise in the Assessment Year 2027-28, i.e., 48 months from the end of the AY
(2023-24) in which shares are allotted. The tax liability for the AY 2027-28
shall be computed as under:

Particulars Amount (in Rs.)

Total tax liability for Assessment Year 2023-24 after 44,40,150
considering the perquisite value of ESOPs

Tax already paid at the time of filing of return for the

13,66,200
Assessment Year 2023-24 excluding the tax liability
attributable to ESOPs

Differential amount to be deducted or paid by the 30,73,950

employer or employee in the Assessment Year 2027-28
towards the tax liability attributable to ESOPs
Regulatory Insights: ESOPs for Persons
Resident in India (PRIs) under FEMA

The Foreign Exchange Management Act (FEMA), 1999, governs the

rules regarding Foreign Exchange transactions in India, including
those related to ESOPs.
ESOPs offered by foreign companies to PRIs are regulated by RBI to
ensure compliance with foreign exchange laws, governing the
issuance, transfer, and sale of shares to prevent illegal cross-border
fund movement.

Under FEMA, Persons Resident in India (PRI) working for either a

foreign company or an Indian company with an overseas Joint
Venture (JV) or Wholly Owned Subsidiary (WOS) are allowed to
participate in Employee Stock Option Plans (ESOPs) of the foreign
company or overseas JV/WOS, subject to below conditions:

1. General Permission
from RBI
General permission from
RBI is required for PRIs to
acquire shares under
cashless ESOPs, provided
it doesn't involve any
remittance from
India
2. Exercise 3. Remittances
via Liberalized via AD Banks
Remittance Scheme AD banks can permit remittances
PRIs can exercise ESOP for ESOP share purchases from
shares by remitting funds a foreign company if:
under the LRS (up to USD • The ESOP is offered globally
250,000 per FY), provided the on a uniform basis.
sale proceeds are repatriated to • The Indian company submits
India. Otherwise, prior annual return to RBI with
RBI approval is remittance and
needed. beneficiary details.

PRI must ensure repatriation, of sale proceeds in India, immediately

on receipt of funds and in any case not later than 90 days from the
date of sale of such securities.
Thank You
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