ARTICLE
14 January 2021

Tax On ESOPs Deferred For Start-Ups

I
Ikigai Law

Contributor

Ikigai Law is an award-winning law firm with a sharp focus on technology and innovation-led businesses. We advise clients from high impact startups to mature market-leading companies and are often at the forefront of policy and regulatory debates for emerging business models. Our TMT practice is ranked by Chambers and we were named Boutique Law Firm of the Year in 2019 by Asian Law Business.
This piece has been authored by Janarth Visvanathan, Associate, with inputs from Anirudh Rastogi, Managing Partner at Ikigai Law.
India Tax
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Tax implications on exercise of ESOPs often render them less than useful. Budget 2020 changes this by deferring the tax liability.

When employees exercised their employee stock options (ESOPs) and collected shares, they were, until recently, subjected to income tax (30%+) on the entire value of the shares (less price paid for exercise). These startup shares, often illiquid, could potentially be worth something in the future (or not), but the tax is certain and immediate. Amendments in the Budget in 2020, have neutralised the sting. The Budget 1 announced a slew of measures for the benefit of the Indian start-up sector. As part of that, the Government deferred the payment of income tax on ESOPs from the time of exercise of ESOPs. Now, the tax liability arises within 14 days from any of the following events, whichever is the earliest2:

  1. after the expiry of 48 months from the end of the relevant assessment year; or
  2. from the date of the sale of such ESOP shares by the assessee; or
  3. from the date of the taxpayer ceasing to be an employee of the ESOP allotting employer.

Liability for deducting tax at source (TDS) on the startup also stands deferred.

These benefits are available only for eligible startups. The eligibility criteria are3:

  1. It is incorporated on or after the April 1st, 2016 but before April 1st, 2021;
  2. The total turnover of its business does not exceed twenty-five crore rupees in any of the previous years beginning on or after the April 1st, 2016 and ending on the March 31st, 2021; and
  3. It holds a certificate of eligible business from the Inter-Ministerial Board of certification as notified in the Official Gazette by the Central Government.

Startups which satisfy these criteria cumulatively will be eligible for the deferred ESOP tax payment benefit.

Conclusion

The newly introduced deference of tax payment on ESOPs will help start-ups attract and retain high-quality employees. The tax on ESOPs has been deferred now to such time when the employee is able to sell the exercised shares and pay tax from such proceeds. They have up to 48 months from the end of the assessment year when the ESOPs were exercised, to sell the shares. The sore point however is that this benefit ceases when the employee decides to change jobs. This would mean that the employee has to pay from her pocket or allow the options to lapse. The problem remains for employees who decide to change jobs. But, overall, this is a welcome change.

Footnotes

1. Finance Act 2020.

2. Section 156 (2), Income Tax Act, 1961.

3. Section 80-IAC, Income Tax Act 1961.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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