In what you need to know about ESOPs, we explained what an Employee Stock Option Plan is and how it is structured.  

Here are six most commonly asked questions with reference to the taxes ESOPs can attract.

1. Are ESOPs taxed when they are given to me?

No, an ESOP is not taxed when you get the shares. You are taxed, however, when you sell them. This means you will be taxed on the profit you make when you sell the shares. 

You also have the option of gifting the shares or transfering them to another person under an irrevocable deed. This is a legal document that says you have handed them over to someone else and they are now the rightful owners, not you.

If you choose this option, you don't have to pay tax. But the person to whom the shares have been gifted/ transferred will be taxed when s/he sells it and make a profit.

2. What tax will be applicable?

You will have to pay capital gains tax.

When you sell any asset you own (house, land, shares, mutual fund units, gold, debentures, bonds) and you make a profit on the sale, it is known as capital gain. The tax you pay on this profit is called the capital gains tax.

Capital gains tax is nothing but the difference between the sale price (price at which you sell the shares) and the issue price (the price at which shares are offered to you).

If you sell the shares within a year of allotment (within 12 months of acquiring them), it will be known as short-term capital gain.

If you sell the shares after a year of allotment (after 12 months of acquiring them), it will be known as long-term capital gain.

3. If I gift the shares to someone, how is the time frame calculated? Is it from the time I get the shares from the company or from the time I gift the shares?

Section 49(1) of the Income Tax Act 1961 specifies that the cost incurred by the previous owner would be that of the new owner. This means the tax guys will base their calculations on the price at which the shares were sold to you, and not on the value of the shares at the time at which they were transferred.

Also, the period of holding by the previous owner would be considered in determining whether the asset is a long or short-term one. Again, this means the tax guys will look at the date on which you got the shares; they are not concerned with the date on which you transfer them to anyone else.

So the period of calculating capital gain will start from the time you acquired it. And the value of the capital gain will be calculated at the cost at which you acquired it.

4. What is the tax rate?

Let's say the shares are listed and sold in India.

If you have a short-term capital gain, you have to pay tax at the rate of 10% (plus surcharge, if applicable). 

Long-term gains are exempt from tax.

If the shares are listed and sold abroad, short-term capital gain is added to your overall income and taxed according to your slab rate.

Long-term capital gain is taxed at 20%.

5. What if I am a non-resident Indian?

Let's say the shares are listed and sold in India.

If you fall under the short-term capital gain category, you have to pay tax at the rate of 10% (plus surcharge, if applicable). 

Long-term gains are exempt from tax.

If your shares are listed and sold abroad, the profit you make on selling these shares will not be taxable in India. This is because the gains occur outside India.

6. Do I have to pay a security transaction tax?

If you sell your shares on or after October 1, 2004, you need to pay the Securities Transaction Tax in India. This is tax levied on the sale of shares.  

STT will also be levied abroad as per the rules of the country you are living in.

Illustration: Dominic Xavier