With this boom in employee retention, Employee Stock Option Plans have gained great prominence. On the other hand, most employees are still confused about how much and when ESOPs will be taxed. Let’s explore ESOP tax, its meaning, calculations, and how it may help pursue your financial needs.
What Are ESOPs and How Do They Work?
ESOPs or employee stock option plans are instruments that companies use to provide their employees with stakeholding. Besides being paid a salary, employees can purchase company stock at an agreed fixed price, known as the grant price.
How do ESOPs work? Here is a quick step-by-step process:
| Stage | Description |
| Grant | The company offers its employees the right to buy shares at a set price (e.g. ₹50/share) |
| Vesting | The employee then becomes eligible to exercise options over time, like 25% a year |
| Exercise | The employee buys the shares after a certain period, like 3 years, at a grant price |
| Sale | The shares are finally sold, mostly at a higher market price |
ESOP Taxation in India: Two Taxable Events
ESOP taxation in India happens in two stages. Below is where it gets confusing, and people end up paying unexpected bills:
1. At the Time of Exercise
The difference between the fair market value (FMV) on the exercise date and the exercise price is treated as a perquisite in the hands of the employee and taxed under the head “Salaries”.
Example:
- FMV on exercise date = ₹200
- Exercise price = ₹50
- Taxable perquisite = ₹150 per share
This is added to your salary and taxed as per your income slab.
2. At the Time of Sale
When the employees eventually sell the shares, they will also be liable for tax on capital gains.
| Condition | Type of Gain | Tax Rate |
| Held > 24 months (unlisted) | Long-term | 20% with indexation |
| Held ≤ 24 months (unlisted) | Short-term | As per the income tax slab |
| Held > 12 months (listed) | Long-term | 10% (above ₹1 lakh gains) |
| Held ≤ 12 months (listed) | Short-term | 15% |
ESOP Tax Calculation: A Simple Example
Let’s say you received 1,000 ESOPs with an exercise price of ₹100. After 3 years, you exercised them when the FMV was ₹300 and sold them a year later at ₹500.
| Component | Amount |
| Prerequisite (Taxed as salary) | ₹200 x 1,000 = ₹2L |
| Sale price | ₹500 x 1,000 = ₹5L |
| Capital gains | ₹500 – ₹300 = ₹200 x 1,000 = ₹2L |
So, you will be required to pay:
- Income tax on ₹2 lakh at your slab rate (for exercise)
- 10% or 20% on ₹2 lakh (for capital gain), based on whether shares are listed or unlisted
ESOP Tax Benefits You Should Know
Below are some of the financial benefits offered by ESOPs:
- Wealth Creation: Early-stage employees in startups can get opportunities to gain massive returns.
- Deferred Tax (Startups only): DPIIT-recognised startups can defer tax payment for up to 5 years or till exit/sale.
- Lower Capital Gains (Listed Shares): After 1 year, long-term capital gains are taxed at just 10% above ₹1 lakh.
RSU Stock vs ESOPs: Know the Difference
While ESOPs are common in Indian startups, multinational companies often offer Restricted Stock Units (RSUs).
| Feature | ESOP | RSU Stock |
| Ownership | Only after exercise | Granted directly after vesting |
| Taxation | On exercise + sale | On vesting + sale |
| Cost to Employee | Pay to buy shares | Usually free |
Tips to Reduce ESOP Tax Burden
Here’s how you can optimise your tax liability on ESOPs:
- Time the exercise: If you’re nearing the financial year-end, consider if exercising next year lowers your overall slab rate.
- Defer in startups: If you’re at a DPIIT-registered startup, use the deferred ESOP taxation benefit.
- Sell smart: Holding shares long-term (more than 24 months for unlisted, 12 for listed) can reduce your capital gains tax.
- Track FMV accurately: Always get a proper FMV certificate, especially for unlisted shares.
How Platforms Like Dhan Support ESOP Holders
Managing ESOPs, taxes, and equity decisions can be complex. Platforms like Dhan provide modern investors and startup employees with tools to track and manage their equity portfolios easily. Dhan offers:
- Low brokerage for equity transactions
- Real-time market analytics
- Tax insights for stock sales
- Custom dashboards to track investments
Common Mistakes to Avoid in ESOP Taxation
- Ignoring the tax at exercise: Exercising triggers a tax event even if you don’t sell shares.
- Missing FMV documentation: This is especially critical for unlisted companies.
- Assuming all ESOPs are tax-free: No, they’re not. Only the gains post-sale may get favourable rates.
- Not setting aside funds: Since tax is due at exercise, keep liquidity ready.
Take Control of Your ESOP Journey and Maximise Returns
Understanding ESOP taxation is not merely owing taxes, but the full command over your equity. Tax burden can be reduced through proper planning so that you can maximise the wealth-building potential of ESOP.
You have held ESOPs in a growing company, and now is the time to be educated, calculate exposure, and make fast decisions. Learn about essential trading techniques to make a smart investment choice.
Looking for more smart investing tips? Visit Dhan’s MadeForTrade community and get all the insights on equities, mutual funds, and personal finance strategies.
