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Employee Stock Ownership Plan for employees working in startup and corporate world i.e. ESOPs It is considered the biggest means of wealth creation. When an employee sees a package of ESOPs worth ₹1 crore in the offer letter or their shares are valued at ₹1 crore in a company’s buyback/IPO, many people assume that the entire amount will be deposited in their bank account.
However, the reality is quite different from this. When employees sell shares by exercising their options, after deducting tax they get Only ₹ 59 lakh to ₹ 68 lakh Only these survive. The remaining ₹32 to ₹41 lakh is deducted as tax, surcharge and cess. Let us understand what is the complete mathematics of Dual Stage Taxation on ESOPs under Indian Income Tax laws.
ESOPs are taxed at two different levels
Under the Indian Income Tax Act, tax on ESOPs is calculated in two stages:
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First Step – At the Time of Exercise (Perquisite Tax): When you convert (exercise) your vested options into shares, the difference between the fair market value (FMV) of the shares on that day and the strike price you paid (Exercise Price) is considered as part of the salary (Perquisite). On this difference, TDS is deducted as per your highest income tax slab rate (30% + surcharge + 4% cess, which can go up to 39%).
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Second Step – At the time of selling shares (Capital Gains Tax): When you sell those shares through buyback, secondary sale or on the stock exchange, the profit between the sale price and the FMV on the day of exercise is taxable as capital gains tax.
Accurate calculation of tax on ESOPs of ₹1 crore
Suppose a tech professional has options for 10,000 shares:
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Exercise Price: ₹10 per share (Total cost: ₹1,00,000)
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FMV during exercise: ₹700 per share (Value: ₹70,00,000)
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Final Sale Price: ₹1,000 per share (Total Sale Value: ₹1,00,00,000 i.e. ₹1 crore)
Tax Deduction Details:
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1. Perquisite Value: $(₹700 – ₹10) \times 10,000 = ₹69,00,000$ (This amount is added to the salary).
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2. Capital Gains Value: $(₹1,000 – ₹700) \times 10,000 = ₹30,00,000$.
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3. Exercise Cost: ₹1.00 lakh
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Total Taxes and Cost: ₹23.68 lakh + ₹3.90 lakh + ₹1 lakh = ₹28.58 lakh to ₹35 lakh
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In-hand (Net Realization) received by the employee: ₹1 crore – ₹35 lakh = approximately ₹65 lakh
(Note: If the employee’s other income already exceeds ₹50 lakh or ₹1 crore, the total tax liability may reach ₹41 lakh due to increase in surcharge, thereby reducing the in-hand amount to ₹59 lakh.)
3 Smart Ways to Reduce ESOPs Tax
According to financial planners, this tax shock can be reduced to a great extent by following certain strategies:
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1. Keep the holding period more than 24 months: Hold unlisted shares for at least 24 months (12 months for listed) after exercise. This will result in long-term capital gains (LTCG) tax of only 12.5% instead of short-term capital gains (which are taxed at slab rate 30%+).
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2. Benefit of DPIIT Startup Tax Deferral: If your employer is a recognized DPIIT startup, acquisition tax under section 192(1C) can be deferred for 48 months, until leaving the job or selling shares.
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3. Do exercise in installments (Staggered Exercise): Divide all options over different years instead of encashing them in the same financial year to avoid falling into the heavy surcharge bracket (10% to 25%) in a single year.