Does Tax Relaxation On ESOP Affect Startups In India?

The Finance Minister noticed that during their developmental years, Start-ups generally use Employee Stock Option Plan (ESOP) to attract and hold highly talented employees. Right now, ESOPs are taxable as perquisites at the time of exercise. So as to give rise to the start-up ecosystem, the Finance Minister has proposed to relax the duty of taxation on the employees by discontinuing the tax payment till they leave the company or for five years or when they sell their shares, whichever is earliest.

A qualified Start-up having turnover up to Rs. 25 crores is allowed deduction of 100% on its profits for three consecutive assessment years out of seven years if the total turnover does not exceed Rs. 25 crore rupees. The Finance Minister has proposed to expand this limit to Rs. 100 crore. She has additionally proposed to extend the period of eligibility for the claim of deduction from the current 7 years to 10 years.

For the time being, start-ups mostly use ESOPs to bring and hold extremely talented employees. ESOPs are a significant part of the compensation of these employees. As of now, ESOPs are taxable. This leads to a cash flow problem for the employees who don't sell their shares immediately and keep on holding them for the long term.

It has been a long-standing demand from the startup network to change the guidelines for ESOPs, which meant employees need to pay tax at the time of allotment of securities.

How ESOP Affects for Startups?

For startups bring in great talent at a premium salary has always been a great challenge. Here’s the place where ESOPs come in to help startups obtaining the correct sort of talent, even if they can't afford the high salaries that corporates pay. This is because startups can offer employees a bit of the company or ESOPs over a specific period of time called the vesting period. After the vesting period, the employees are allowed to practice their ESOPs.

Usually, the stock price offered to the employees under ESOP (exercise price) is less than the fair market value of the stock.

Currently, while the Finance Bill 2020 is yet to be enacted, ESOPs are taxed twice under section 17(2) of the Income Tax Act.

Further Kunal Bahl tweeted in support of the tax relaxation on ESOP.

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