ESOP-The Good, Bad and Ugly word of Startup World

ESOP——- the most notorious and discussed word in start-up and professional field in the last 10-15 days. Albeit it is not a new word but it again came into the discussion after the learned Finance Minister proposed some amendments in the taxation treatment for the same. The word is popular in IT/ITes enabled services and Startup world as it gives an opportunity to the company/organization an opportunity to hire good talented people at a price much below their actual worth. In this case, talented people are given the ESOPs (Employee Stock Option Plans) in the company in addition to the regular salaries being given to them. This GOOD/BAD/UGLY word of the startup arena creates a win-win situation both for the employer as well as employee, viz

• Employees get an opportunity to become the owner of the company in which they are working day and night. By putting a small amount of money (in comparison to the actual market value of the company) in addition to the effort and energy they got the feeling/entitlement of ownership.
• The Employer gets the opportunity to hire talented people without shelling out a large amount of cash and binding them through ownership in the company. The ESOPs are generally allotted to employees on the basis of ESOP policy designed by the company from the time to time and on payment of a small sum of money, which is lower than the market price of the share as on that date.
• Since now we have understood the purpose and benefit of ESOPs so we should try to elaborate on the process involved in alloting these shares to Employees and taxable treatment of the same in their hands.
• So in the first stage, Eligible employees are being chosen to whom ESOPs will be given on achieving a particular milestone (Generally it is for a particular time frame with some cliff period). After completing that milestone ESOPs get vested which, the employee can get allotted in his/her favor and then the taxmen come into the picture. Till now ESOPs are taxed at two stages viz,
• As we explained earlier that ESOPs are allotted at a price lesser than the market price of the shares on the date of vesting, this difference (Market Price minus allotment price is treated as income of the employee (taxable as perquisite u/s 17 of the Income Tax Act, 1961 as Government treat this benefit as part of salary). Now the irony is that the employee has not sold the shares (on the contrary he has just bought the shares) but still he has to pay the taxes. This is the first stage of taxation.
• In the second stage, the employee has to pay taxes at the time of actual sale of shares on the difference between the sales price and the price which was considered as market value at the time of allotment (as perquisite tax explained above was calculated up to the market price of the shares)
• So the process of taxing ESOPs through these two stages is being followed since last more than a decade then what’s new now,
• Here comes the new plan proposed by the Finance Minister in this year’s budget wherein instead of taxing the ESOPs at Two Stages (first at the time of allotment and second at the time of actual sale) it has been proposed to tax the ESOP in EARLIER OF THREE SITUATION VIZ.
  a. 5 years from the date of vesting,
  b. leaving the company and
  c. when shares are being actually sold.

WILL IT BE GOING TO SOLVE THE PROBLEM then the answer is partial yes but Actually No because this benefit of taxing the ESOPs at one stage is being given to Startup Registered with DIPP/DPIIT only (which got incorporated after 1st April 2016 and recognized with Government of India and presently they are hardly 2% of the total startups working in India) so let’s enjoy for them till the time government recognize that other employees are also contributing towards nation-building and employment generation through their organization.