Tax events on ESOPs

Many of the people in metro's today are employeed with multi national companies, and one of the common ways they reward their employees is by giving them stock ownership plans.

Typically these are given in the form of discounted shares that an employee can buy from his monthly salary upto a max limit which is decided based on his salary. They can have a vesting period, means they can only be redeemed only after say 3 years from the date of allotment. Many companies also offer a bonus share when this vesting period ends.

I have often seen that young individuals sell off these shares and use the proceeds to provide for that top end smart-phone or that vacation with friends. Many are not even aware how these stock ownerships are taxed in our country, I have spoken to few and their assumptions were their company has already taken care of tax by deducting from their salary, this is true for RSU's but not for ESOPS. 

Let's understand the tax implications based on an example. Consider an employee of company A purchases 15 stocks of 100$ market price, each at a discount of 40% with a vesting period of 3 years. At the end of these three years, employee would also get a bonus stock for every 5 stocks held. 

Let's see what are the tax events in this whole cycle

At the time of allotment	When the employee is granted the stock, his contribution for the stock purchase equals 60$*15 i.e. 900$ where actual market price was $1500. Hence, company contribution in this case for the purchase is $600. Now, as per income tax laws this is considered fringe benefit for the employee, and the taxable amount will be the total Employer Contribution. Luckily, in this case your employer is required to withhold the income tax due before making your salary payment. And hence you need not worry much as the tax arises but this is paid by company on your behalf and deducted from your salary
Dividends	Big or small, dividends are income for the individual. Now, dividend on stock of companies listed on domestic exchanges are completely free in the hands of stock holder. However, in case of foreign stocks, any dividends received by you will be subject to tax in host country (where stock is listed) and India. The reinvestment of dividend is also regarded as a deemed receipt. You will receive all dividends net of host country tax. However, you should be able to make a claim to the tax authorities for a tax refund, if that country has a relevant tax treaty with India to avoid double taxation.  The gross dividends (the dividend amount before tax withholding by host country) will be subject to income tax in India at your maximum marginal rate.  You are responsible for paying any tax due through your annual tax return or through advanced tax instalments if applicable.
At the time of Sale	Yes, you will be required to pay income tax on any gain arising when you sell your shares as follows: for shares held for 36 months or fewer at your individual tax rate And at 20% (plus Education CESS at a rate of 2% and secondary and higher education CESS at 1% on the total tax) for shares held for longer than 36 months. Where the total income of the employee exceeds INR 10,000,000, a surcharge of 15% would also be levied. In such cases, the tax rate would be 23.69%. Further, cost indexation benefit would be available. Now, in this case while calculating gains the cost of acquisition of shares is 100$ and not 60$, as you have already paid the fringe benefit tax for the employer contribution on the purchase. Since, most cases you sell the shares directly. You are responsible for paying any tax due through your annual tax return or through advanced tax instalments if applicable.
At the time of allotment of bonus shares	When the bonus share is allotted to you by the company. It's very similar to case one, and the value of stocks allotted can be considered as employee contribution. employer is required to withhold the income tax for this bonus share allotted to you. Tax treatment on the sale of these bonus shares is same as like any other share as mentioned above. Just the date of receipt of bonus is considered as date of purchase and the stock value at the time of allotment should be considered as the price of purchase.

I believe this puts fair amount of clarity for the ESOPs and now you should be better equipped to calculate taxes on your ESOPs.