Taxation in case of ESOP shares

I have received shares under the employee stock option plan (ESOP) from my employer. Can you please explain the tax liability on selling these shares?

—Kishore Shah

There are two stages of taxation for shares allotted to employees under ESOP.

The first point is when the shares are allotted by the employer company. The same is taxed as salary or perquisite in the hands of the employee. The second is when the employee sells the shares allotted to her under ESOP. At this stage, the gains are taxed as capital gains.

In the first stage, the difference between the shares’ fair market value (FMV) on the date of exercise and the exercise price paid by the employee, if any, is taxable as perquisite or salary on the date of allotment of shares. Accordingly, the employer would compute and deduct the tax on perquisite or salary resulting from allotment of shares to you under ESOP. The income and the perquisite tax deducted by the company thereon would be reflected in your Form 16.

Further, you have to report the same as part of salary in your personal tax return.

For the purpose of calculating the perquisite value, FMV of the share on the date of exercise of the option has to be determined as per the method specified in Rule 3 of the income tax rules. For shares listed on a recognised stock exchange in India, the FMV shall be average of the opening and closing price on the date of exercise of options subject to the conditions specified in the aforesaid rule. In case of unlisted shares or foreign shares, the FMV has to be determined by a Category I merchant banker registered with the Securities and Exchange Board of India.

When you sell these shares, the gains from the sale will be taxed as capital gains. The capital gains will have to be computed as the difference between the sale proceeds and FMV of the shares that was considered by the employer while computing the perquisite value, including any expenditure that may have been incurred wholly in connection with the sale.

Capital gains tax implications would depend upon the period of holding of shares by you from the allotment date, and whether securities transaction tax (STT) has been paid.

The taxable long-term capital gain, if any, arising from sale of shares can be claimed as exempt from tax by re-investing the sale proceeds either in specified bonds as per conditions specified in section 54EC of the Income-tax Act, 1961, or in one residential house in India as per the conditions specified in section 54F.