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ESOP gets a shot in the arm
Early in May, the Finance Minister announced a number of amendments to the Finance Bill. One of these amendments relating to taxation of employee stock option (ESOP) has a direct bearing on a majority of the workforce many employees in the IT industry today. And especially so for those who will be receiving stock options in the near future.
As per this amendment, the Finance Minister has done away with the dual taxation that was imposed on employees opting for stock options. Till date, these employees had to cough up both income tax on ESOPs (at the time of receiving the option since ESOPs were considered a perk) as well as pay capital gains tax at the time of their sale. Now income tax on ESOPs as a perquisite has been done away with. So, you need to shell out only the capital gains tax at the time of sale of the shares.
The single major benefit is that you do not have to pay up money up front both in the form of income tax as well as the actual cost of buying shares under stock options (may be for a concession). With capital gains tax, you can pay your tax out of the proceeds of your shares sale.
The second question that crops up is what the tax rates are going to be like. Since shares under most stock option plans can be sold only after a year, long-term capital gains tax at a reasonable 10 per cent would be applicable. This needs to be compared to the previous income tax on perquisites, which was closer to the 35 per cent mark.
The next question: how is the capital gains tax computed? That's been simplified too. Now capital gains tax would be computed on the difference between the sale price and the issue price (the price at which you received it from your company). Earlier, capital gains tax was computed on the difference between the sale price and market value of the shares on the date of issue. The current computation has made calculations quite simple and straightforward.
However, there's one aspect to the amendment that ensures that you can no longer completely avoid tax on ESOPs. In the past, employees did manage to avoid capital gains tax by gifting away the options to someone else. But that particular avenue has now been blocked. Now, even if you gift your ESOPs, you would still have to pay capital gains tax. The tax would be calculated on the difference between the market value of the shares on the date of transfer and the issue price (the price at which you received it from your employer). However, in the final analysis, since you do not need to bear the brunt of income tax anymore, this works out much better than before.
These amendments come into effect from the assessment year 2001-02. So for those of you who have already received and exercised options, you would need to re-examine the small print quite carefully to understand where you stand. Currently, there is some ambiguity in how calculations of capital gains tax would be worked out for employees who have already exercised their options. However, for those employees who are receiving options in future, the paperwork, the tax burden and the procedures are pretty clear.
Certainly it looks like it is time you included ESOPs on your list of compensation options. Just a word of caution: make sure the shares are worth owning. In other words, make sure the company you are working for is worth owning.
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