ESOPs have been a significant component of the compensation for the employees of start-ups, as it allows the founders and start-ups to employ highly talented employees at a relatively low salary amount with the balance being made up via ESOPs.
Currently, ESOPs are taxed as perquisites under section 17(2) of the Act read with Rule 3(8)(iii) of the Rules. The taxation of ESOPs is split into two components:
i. Tax on perquisite as income from salary at the time of exercise.
ii. Tax on income from capital gain at the time of sale.
The tax on perquisite is required to be paid at the time of exercising of option which may lead to cash flow problem as this benefit of ESOP is in kind.
In order to ease the burden on the employees of the eligible start-ups (herein referred to as the company), section 192 of the Income-tax Act has been amended, with insertion of new subsection i.e 192(1C)
When to deduct tax?
Eligible start-up is require to deduct tax on issue of ESOP, within 14 days from:
(i) after the expiry of forty eight months from the end of the relevant assessment year; or
(ii) from the date of the sale of such specified security or sweat equity share by the employee; or
(iii) from the date of which the assessee ceases to be the employee of the company; whichever is the earlier
Rate of TDS
Rate of TDS shall be rate in force for financial year in which such shares are allotted to employee.
Case study
Mr. X is an employee of ABC Ltd. (eligible start-up), salary of Mr. X for Previous Year 2021-22 was as follows:
- Basic salary:10,00,000
- DA: 5,00,000
Company allotted 10,000 shares @10 per share as ESOP to Mr. X in the month of Dec 21. FMV on which option exercised is Rs. 4500 per share.
Taxability would be as follows
| Particulars | Amount |
| Basic salary | 10,00,000 |
| DA | 5,00,000 |
| ESOP [10,000 x 4490(4500-10)] | 4,49,00,000 |
| Gross salary | 4,64,00,000 |
| Less: Standard Deduction u/s 16 | (50,000) |
| Net Taxable Salary (A) | 4,63,50,000 |
| Tax on above income (B) | 1,78,32,750 |
| Effective Tax rate (B/A) | 38.47% |
| Tax to be deferred as per section 192(1C) (4,49,00,000 x 38.47%) | 1,72,74,875 |
| Tax to be deducted in PY 21-22 | 5,57,875 |
For PY 2021-2022 ABC Ltd. has to deduct tax of Rs. 5,57,875.
Further, assuming Mr. X have sold 4000 shares for 6000 each in 10th March 2023, tax treatment for PY 2022-23 would be as follows:
| Full value of the consideration (4000 x 6000) would be | 2,40,00,000 |
| Cost of Acquisition (4000 x 4500) | 1,80,00,000 |
| LTCG would be | 60,00,000 |
Now TDS on prerequisite has to be deducted by ABC Ltd. on ESOP upto 24th March 2023 (i.e 14 days from date of sale of shares by Mr. X) as follows:
Rs. 1,72,74,875 x 4000 shares/10000 shares= Rs. 69,09,950
Remaining Tax of Rs. 1,03,64,925 (Rs.1,72,74,875 – Rs. 69,09,950) has to be deducted within 14 days from:
(i) after the expiry of forty-eight months from the end of the relevant assessment year; or
(ii) from the date of the sale of such specified security or sweat equity share by the employee; or
(iii) from the date of which the assessee ceases to be the employee of the company;
whichever is the earlier
Related amendments
Similar amendments have been carried out in section 191 (for assessee to pay the tax direct in case of no TDS) and in section 156 (for notice of demand) and in section 140A (for calculating self-assessment).
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