The ESOP was created by the federal government with the intention of serving as both a corporate finance instrument and a retirement plan for employees and sellers.

In the current situation, a startup employee who obtains an ESOP grant of options is required to pay full income tax after a specified term of holding the options. Employee stock option plans, like profit sharing plans, are employee benefit plans that give employees ownership in the company. A company sells its stock at an extremely low price. These equities are held in an ESOP trust fund until they are exercised or the employee retires or quits the company.

How are ESOPs taxed? When an employee sells such shares, the gain, which is equal to the actual sale price less the fair market value on the date the ESOP option was exercised, is taxed under the heading "Capital Gains." Employee stock option plans (ESOPs) have grown in popularity among corporations, particularly in the IT industry, as a means of attracting and retaining talent.


1. The difference between the fair market value (on exercise day) and the exercise price is taxed as perquisite when the employee has exercised the option, thus agreeing to buy. On this perk, the employer deducts TDS. This amount is shown on the employee's Form 16 and is included in the tax return as part of the total income from salary. Where the shares allotted are those of a listed firm, the fair market value is the average of the opening and closing prices as of that date, according to Rule 3(8) of the Income Tax Rules, 1962. If the shares in question are unlisted, the value of the shares as determined by a Merchant Banker on a certain date shall be considered the unlisted shares' fair market value.

Employees who receive ESOPs from a qualifying start-up will not have to pay tax in the year they exercise the option beginning in FY 2020-21. The TDS on the 'perquisite' is postponed until one of the following situations occurs first: Expiration of five years from the date of ESOP allotment, employee sale of ESOPs, and termination of employment

2. Once the employee has purchased the shares, he may decide to sell them. Another tax event occurs if the employee sells these shares. Capital gains are taxed on the difference between the sale price and the FMV on the exercise date.

When listed shares are held for less than or equal to 12 months, the resulting gain from the sale of such shares is considered short term capital gain and is taxed at a reduced rate of 15% under Section 111A of the Income Tax Act, 1961.

The effect of holding the shares for more than a year is a long-term capital gain of Rs. 1 lakh.

When unlisted shares are held for less than or equal to 24 months, the gain is considered short term capital gain, which is taxed at regular rates like any other income.

When shares are held for more than 24 months, the gain is classified as long-term capital gain, which is taxed at 20% with indexation under Section 112 of the Internal Revenue Code.

ESOPs, which serve as an important pay tool for employees and for businesses in helping to lower attrition rates, will be exempt from dual taxation in 2020, according to company founders and investors. Currently, startup employees must pay tax when they enrol in ESOPs with a vesting schedule, as well as a capital gains tax when they redeem their ESOPs.

Employees' ESOPs have been subjected to double taxation, which has hampered the goal of ESOPs, which was to attract and maintain the best talent pool possible.

"Employees can't afford to pay income tax on ESOPs because the stock isn't publicly traded or liquid. This is why, when employees quit jobs, they typically leave their vested ESOPs behind," stated Sameer Nigam, CEO of PhonePe.

Startups also want the government to play a more active role in incubation and the loosening of public-listing requirements for companies looking to go public.