The Indian government is planning to revamp the tax system for ESOPs, making things way smoother for startup employees. How exciting does that sound!
In the last few years, many employees of startups made big bucks as they exercised their stock options through secondary exits.
But, ESOPs, when converted to shares, are taxed.
To take the sting out, the government is on its way to tax ESOPs for startups, only at the time of sale!
What are ESOPs
ESOP (Employee Stock Ownership Plan) is an employee benefit plan which sparks a great deal of ownership interests in an employee.
In an ESOP, an employee is given stock ownership, usually at no up-front cost.
An ESOP can be considered to be a magnetic part of an employee’s salary. Here’s why.
Employer-employee benefit
ESOPs can potentially be the feather in the cap for managers and employees because of their undeviating performance, presence, and loyalty to the company.
How does this benefit the employer, you ask?
With ESOPs, the company remains in the hands of the people who the employer trusts.
Tax benefit
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An ESOP can give you a whole bunch of tax advantages – as long as there’s a detailed set of standardizations the business aligns with.
No taxes are going to be due from your end when ESOPs hit your account. Tax deferrals for employees is another sweet deal! Distributions allotted to a partaker’s account will be deferred for as long as they are a part of the ESOP plan.
In-house buyers
ESOPs can come in handy for those business owners trying to sell their business. This helps avoid the big problem of finding the right buyer in a big pool of competition.
Employee ownership
An ESOP plan promotes an opportunity for employees to take ownership of the company.
How ESOPs work
In an ESOP, the company first sets up a trust fund and contributes shares of its own stock to buy existing shares, into the trust fund.
It’s also possible for the ESOP to take on a loan to purchase new or existing shares from the company contributing to the plan to help repay the loan.
Regardless, the contributions of the company to the trust fund are taxable.
The shares in the trust fund are allotted to an employee’s account. As and when the employee reaches a higher level of seniority in the company, they get an increased right to the shares allotted to them. This process is called vesting.
The existing tax implications
Employees get taxed when they exercise their options and convert their ESOP to shares.
In the case of listed companies, an employee has the flexibility to sell shares on a stock exchange and put together money to pay tax on conversion.
But, in the case of startups, there usually isn’t a ready buyer or a market where shares can be sold. ESOP holders also face issues in terms of the period of holding of shares.
This brings down the capability to bring together the necessary funds and pay taxes for the value of shares.
The change
The Department for Promotion of Industry and Internal Trade (DPIIT) has started discussions with the Finance Ministry to tax ESOP only at the time of actual sale, in a manner to make the country a lot more tangible to become a hub for startups.
With the economy favoring startups, these problems are needed to be solved, to make the situation a lot lighter for employees with ESOP.
This change, when implemented, will aid startups to retain talent for the long run as well as boost interest of potential talent to be a part of the company.
