ESOPs can significantly boost your wealth, but taxation can take a huge part away. Learn with us how to save tax on ESOPs and minimize your tax liability
We offer you the best strategies to save taxes on ESOPs and also provide you an overview of how they are taxed.
Quick Breakdown of ESOP Taxation in India
Employee Stock Ownership Plans (ESOPs) are taxed twice in India: at the time of exercise and at the time of sale. Here’s a overview of how it works:
At the time of Exercise
- When the employee exercises their share option, the difference between the Fair Market Value (FMV) of the shares and the exercise price is taxed as salary income.
- They are taxed according to the employee’s income tax slab rate.
- For listed companies, FMV is based on the average of the opening and closing prices on the date of exercise. For unlisted shares, it is based on a valuation done by a merchant banker
At the time of Sale
When the employee sells the shares, Capital Gains Tax is applied.
- Short-Term Capital Gains (STCG): If the shares are sold within 12 months, they are taxed at 15%.
- Long-Term Capital Gains (LTCG): If the shares are sold after 12 months, taxed at 12.5% on gains above Rs 1 lakh.
How to Save Tax on ESOPs: 15 Tax Savings’ Strategies
To save tax on ESOPs in India, employees can utilize various strategies such as:
Purchase Residential Flat or Construct a House
You can reinvest the capital gains from selling ESOP shares into buying a residential property or constructing a house.
This can help you claim an exemption under Section 54F, reducing your tax liability.
Hold Shares for Longer Duration:
By holding shares for more than 24 months (for unlisted shares) or more than 12 months (for listed shares), employees can qualify for long-term capital gains (LTCG) tax treatment.
LTCG is taxed at a lower rate compared to short-term capital gains (STCG), which can reduce your tax liability upon sale.
Defer Tax Payment:
For employees of eligible startups, the tax on the ESOP can be deferred for up to 5 years,meaning they do not need to pay tax at the time of exercising options
This gives time to plan tax payments efficiently.
Utilize Losses to Offset Gains:
You can reduce your tax liability by using capital losses from other investments (like stocks) to offset the capital gains from selling ESOPs.
This strategy helps reduce overall taxable income and lowers tax liability.
Consider Tax Planning with Financial Advisors:
Engaging with financial advisors can give you access to customized strategies for managing tax implications related to ESOPs.
Advisors from top firms like PKC Management Consulting can help employees understand complex tax regulations and optimize their tax positions effectively.
Invest in Capital Gain Bonds:
Under Section 54EC, you can invest the capital gains from ESOP sales into capital gain bonds (e.g., REC, NHAI bonds) within 6 months.
This investment makes you eligible for tax exemption.
Understand Double Taxation Avoidance Agreements (DTAA):
If you are receiving ESOPs from foreign companies, understand and utilize DTAA provisions to eliminate double taxation on income earned abroad.
You can claim credits for taxes paid in another country against your Indian tax liabilities.
- l
Timing of Exercise and Sale:
Exercise options when the Fair Market Value (FMV) is low and sell when it is high.
This can minimize perquisite income and maximize capital gains, thereby optimizing tax outcomes
Utilize Section 87A
Section 87A provides a rebate for individuals with total taxable income up to Rs 5 lakh.
Employees can utilize this provision to reduce their overall tax liability if their income falls within this threshold, including income from ESOPs.
Look Into Debt Mutual Funds
Invest the proceeds from ESOP sales into debt mutual funds for better post-tax returns.
These funds can help in lowering your taxable income over time.
Invest in National Pension System (NPS)
Contribute to the NPS and claim deductions under Section 80CCD, which helps reduce taxable income.
This deduction is particularly useful for long-term retirement planning while simultaneously lowering current tax liabilities.
Explore Equity-linked savings schemes (ELSS)
You can invest in ELSS for tax benefits under Section 80C.
ELSS funds also offer long-term growth and a tax-saving option on your ESOP gains.
Split Sales Over Financial Years
If possible, split the sale of ESOP shares across two financial years to spread out the tax liability.
This helps prevent a higher tax rate from being applied to the entire gain in one year.
Gifting ESOPs to Family Members
Start-ups can save tax on ESOPs by utilizing deferred tax payment schemes under the Income Tax Act.
During tax holiday periods, they can defer tax liabilities until the company becomes profitable. This strategy helps manage cash flow while incentivizing employee ownership effectively.
15.
Gifting ESOPs to Family Members
Consider gifting ESOP shares to family members who fall into lower tax brackets.
This can help distribute the tax burden and reduce the overall tax liability on ESOP gains within the family.
Frequently Asked Questions
- How to reduce tax on ESOPs?
To reduce tax on ESOPs, employees can hold shares for longer to qualify for lower long-term capital gains rates and invest in residential property to claim exemptions under Section 54F.
- How much tax do you pay on ESOP?
Tax on ESOPs is paid in two stages: as a prerequisite when exercising options and as capital gains upon sale.
- Is ESOP expenses tax deductible?
Yes, employers can claim a tax deduction for the cost of shares issued under the ESOP scheme, which is allowed in the year the employee exercises the option and acquires the shares.
- Where to declare ESOP in ITR?
ESOPs should be declared in the Income Tax Return (ITR) under the head “Salary” as perquisites and also reported under “Capital Gains” when shares are sold.
- Is ESOP exempt?
ESOPs are not exempt from tax; they are taxable as perquisites at exercise and as capital gains upon sale, although certain exemptions may apply under specific conditions.
- Is TDS applicable on ESOPs?
Yes, Tax Deducted at Source (TDS) is applicable on the perquisite value of ESOPs when options are exercised, with specific rules for eligible start-ups regarding deferment of TDS.
