Budget 2020: Why the easing of ESOP taxation rules is a boon for startups

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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The Budget 2020 brought cheer to certain startups by way of relief from payment of taxes on employees’ stock options (ESOPs) at the point when the potential gains of ESOP are still unrealised.

Startups use ESOPs to attract and retain highly talented employees as well as compensate them adequately without taking a hit on their cash flows. From the point of view of the employees, the perquisite tax on ESOPs is triggered at the time of allotment of shares, pursuant to the exercise of stock options. However, at this point, since there is no liquidity for these shares, the employees have to make the tax payment out of their pocket, resulting in the employees not viewing the ESOPs favourably, especially those who have ESOPs as a significant component of their compensation.

The Budget 2020 proposes to defer the timing of payment of taxes on ESOPs to earlier of:

1. Five years from the end of the financial year in which allotment of shares is made.
2. Until the employee leaves the company.
3. Until the employee sells the shares.

The taxes on the ESOP should be paid within 14 days of the occurrence of the above event.

However, the above relaxation does not apply to all startups recognised by the Department for Promotion of Industry and Internal Trade (DPIIT), but only those companies set up between April 1, 2017 and March 31, 2020 and are approved by the inter-ministerial board of the government.

ESOPs are still taxable

The important point to note is that there is still no change in the taxation of ESOPs from the present tax law. ESOPs are still taxable at the time of exercise of stock options by the employee i.e. on the allotment of shares. The tax is determined as the fair market value of the shares allotted at the time of exercise, reduced by the option price paid by the employee. Subsequently, the shares once sold, are subject to capital gains tax.

While the above proposal is a good move towards handholding startups during their initial phase of liquidity crunch, the ask of the wider startup community may be that the relaxation be extended to all startups recognised by the DPIIT.

In addition to the above, the finance minister also proposed additional relief measures to the startup community by offering 100 percent deduction in profits for three consecutive tax years in a 10-year window (increased from earlier seven-year window), for eligible startups having turnover of up to Rs 100 crore (increased from earlier Rs 25 crore). The government has also committed to provide early seed funding for ideation and development in early-stage startups.

Shalini Jain is Partner, People Advisory Services at EY India.

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KV Prasad Journo follow politics, process in Parliament and US Congress. Former Congressional APSA-Fulbright Fellow