Exercise tax incidence arises only when an employee is granted ESOPs and he/she exercises these equity grants. Note that there is no tax implication during the vesting period.
Upon exercise, if the Fair Market Value (FMV) of the share is more than the exercise price then it becomes gain for employees and such a gain is treated as a ‘Perquisite’ in the hands of employees as per Section 17 of the Income Tax Act (1961). As a result, the employer (i.e. startup) is liable to deduct TDS on such a perquisite depending on the tax bracket in which the employee falls, and deposit the same with the government before the 7th of the next month. This amount appears in the employee’s Form 16 and is included as a part of his total salary.
Recently, in #Budget2020, FM Nirmala Sitharaman proposed the deferral of exercise tax to the time of sale of shares, 5 years, or when the employee quits the company, whichever is earlier. According to the proposal, the tax in such a scenario will now be required to be paid as follows:
- After the expiry of 5 years from the end of the relevant financial year in which shares are allotted, or
- From the date of the sale of such specified security or sweat equity share by the employee, or
- From the date on which the employee quits.
Such tax has to be deposited within 14 days of any of the above-mentioned events taking place.