How ESOP taxes are calculated for eligible startup employees?


Different schemes are delivered with the aid of using the employers; however, the entire advantage accrues to the person while the lock-in situations are met; or vesting length is finished with the aid of using the personnel.

Tax implications in the hands of employees 

There are two steps to imposing an ESOP on an employee. We have briefly discussed each step as below 

  1. The employee, on the exercise date of the ESOP option, is considered a precondition/incentive for wages in the hands of the employee and is at the same time taxable as “wage income”.
  2. Taxed as capital gains: when an employee sells those shares, the gain of i.e. the actual sale price minus fair market value at the ESOP option exercise date, will be taxed under the heading “capital gains“. 

In general, early-stage taxation results in an additional tax burden for employees, as they then receive only stock and no real capital inflow. Taxing such an incentive would be out of pocket because the employer would deduct additional taxes if they did not sell the stock immediately. 

Relief for employees of eligible startups 

Given that India is the third-largest startup ecosystem in India, the government recently eased the ESOP taxation specifically for Indian startups in the early stages; that is, employees are not required to pay taxes immediately after the shares awarded to them under the ESOP are issued by a qualified startup. 

The deferred tax/deferred income tax regime for these benefits applies from ESOPs issued on/after April 1, 2020. With this, the employer will now have to withhold tax on these ESOP benefits after four years.

What Makes a Qualifying Startup?

Since this deferred tax only applies to employees of eligible startups, it is important to analyze whether a startup is eligible to pay income tax.

A qualifying start-up has been defined to include a company or limited liability partnership engaged in a qualifying activity: innovating, developing, or improving a product or process or a service or a scalable business model with high wealth or job creation potential meets the following conditions.

(a) It was incorporated from 01.04.2016 to 01.04.2022.

(b) Its turnover does not exceed Rs 100 crore. 

(c) He has a certificate from the Interministerial Certification Board of India 


Therefore, in case the worker has received ESOPs from his employer, to determine his income tax payable on these ESOPs, he should check that the employer has sufficient eligibility for a start-up, whether or not the conditions for claiming deferred tax payment for such ESOPs granted by a qualified start is met or not. 

In addition, to determine the amount of tax payable, employees must know the fair market value of these ESOPs at the exercise date. These details will be important in determining his income tax liability.

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