Diwali Bonus and Esops: How festive benefits to employees will be taxed after Budget 2024 

Diwali bonus: India's EV-as-a-service sector member Zypp Electric initiated the 'Zypp Diwali Bonanza' campaign under which Zypp's delivery partners, also known as Zypp Pilots, were rewarded for their dedicated efforts, especially during the bustling Diwali season. Notably, Zypp's latest Diwali campaign includes the provision of an Employee Stock Ownership Plan (ESOP) to the five longest-serving Zypp Pilots, with a value of Rs 15 lakh each.

Reliance Retail, ahead of its initial public offering (IPO), awarded employee stock option plans (ESOPs) valued at Rs 351 crore to 15 senior executives during the prior financial year. The retail division of Reliance Industries allocated 4.417 million shares, each at a face value of Rs 10, at a price of Rs 796.5 per share to the company's top leaders. Reliance Retail announced that its board will implement the necessary actions to list the ESOP shares in the event that the IPO moves forward.

In ESOP, a company, who is the employer in this case, provides its stocks at minimal or discounted rates. These stocks are held in an ESOP trust until the vesting period, at which point employees may choose to exercise their options or depart from the company. When an employer grants securities to an employee through an Employee Stock Option Plan (ESOP) at no cost or at a reduced price, it is considered a taxable benefit in the year in which the securities are allocated to the employee.

Taxation of ESOPs

During exercise, when an employee agrees to purchase stock options, the variance between the Fair Market Value (FMV) on the exercise date and the exercise price is considered a perquisite and subject to taxation. The employer withholds Tax Deducted at Source (TDS) on this perquisite, which is reflected in the employee's Form 16 and included as part of their total income from salary in the tax return. 

Starting from the Financial Year 2020-21, employees receiving ESOPs from eligible startups are exempt from paying taxes in the year that they exercise their options.

The TDS on the 'perquisite' will be deferred until the earlier of the following events:

Expiry of five years from the year of allotment of ESOPs
Date of sale of the ESOPs by the employee
Date of termination of employment

Upon the sale of the ESOPs by the employee, the TDS will be triggered. The employee has the option to sell the shares once they are purchased. If the employee chooses to sell, a tax event will occur. The capital gains tax will be applied to the difference between the sale price and the FMV on the exercise date.

Capital Gain taxation

The tax considerations for ESOPs involve two components: (a) Tax on the perquisite as salary income upon exercise, and (b) Tax on the capital gain income upon sale.

CA (Dr.) Suresh Surana explained:

At the time of exercise: Under Section 17(2) of the Income Tax Act, 1961 (hereinafter referred to as ’the IT Act’), ESOPs are taxable in the hands of the employees as perquisites in the financial year in which such ESOPs are allotted to the company.  For the said purpose, the taxable amount would be determined as the Fair market value (FMV) of the shares on the date of exercising such option less any amount paid by the employee for such ESOPs. Such fair market value would be computed differently for listed as well as unlisted securities in accordance with Rule 3(8) of the Income Tax Rules, 1962.

It is notable that,  w.e.f. Financial Year (FY) 2020-21, in case of an employee receiving ESOPs from an eligible start-up u/s 80-IAC of the IT Act, the TDS on perquisite would be deferred to within 14 days from the earliest of the following period:

(i)   After the expiry of 48 months (i.e. 4 years) from the end of the relevant assessment year (i.e. 5 years from the end of the relevant FY); or

(ii)  from the date of the sale of such ESOPs by the assessee/ employee; or

(iii)  from the date of the assessee ceasing to be the employee of the eligible start-up,

b)   At the time of Selling: ESOPs when sold by the employee would be subjected to capital gains tax. The capital gains tax rate would depend upon the category of the share i.e. whether listed or unlisted and the period of holding for such share.

In case of listed shares, long term capital gains arising from shares held for more than one year would be subjected to tax @ 10% (enhanced to 12.5% w.e.f. 23rd July 2024) (without indexation) u/s 112A of the IT Act and such tax would be levied on gains exceeding Rs. 1,00,000 (threshold enhanced to Rs. 1,25,000 w.e.f. FY 2024-25) whereas short term capital gains would be subjected to tax @ 15% (enhanced to 12.5% w.e.f. 23rd July 2024) in accordance with Section 111A of the IT Act.

Unlisted shares

In case of unlisted shares, the threshold period for the purpose of determining the nature of gains i.e. whether long term or short term would be 24 months. Accordingly, long term capital gains would be subjected to tax @ 20% (after indexation) (12.5% without indexation w.e.f. 23rd July 2024) whereas short term capital gains would be taxed as per the marginal slab rates applicable to the employee.

It is pertinent to note that for the purpose of computing the nature of capital gains, the period of holding shall be considered from the date of allotment of ESOPs till the date of sale/ transfer of shares by the employee.

It is notable that ESOPs of foreign companies are required to be reported in the Income Tax return of every Resident and Ordinarily Resident (RoR) in the schedule for Foreign Assets i.e. (Schedule FA) of the ITR.  In case of non-disclosure of such foreign ESOPs in the income tax return, the income tax authorities can issue a notice to the individual for such undisclosed asset and can also treat such income tax return as a defective return u/s 139(9) of the IT Act. Moreover, “The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 (‘BMA’)” imposes more stringent penalty of Rs. 10 lakhs for non-disclosure of a foreign asset in Schedule FA.