In India, the taxation of income earned through income tax an Employee Stock Option Plan (ESOP) depends on whether the options vest in the employee’s hands or not. If the options vest immediately upon grant, the employee is liable to pay tax on the fair market value of the shares minus the exercise price at the time of vesting.

However, if the ESOP qualifies as a “stock option” under Section 10(23BA) income tax of the Income Tax Act, the tax liability can be deferred until the shares are sold. This means the employee does not have to pay taxes at the time of vesting, but only when they eventually sell the shares.

Conditions for deferring TDS on ESOP income:

1. The ESOP must be approved by the shareholders of the company.
2. The exercise price of the options must be at least equal to the fair market value of the shares at the time of grant.
3. The options must not be transferable.
4. The employee must hold the shares for at least one year after exercising the options.

Deferring TDS:

If the ESOP meets all the above conditions, the employer is not required to deduct tax at source (TDS) income tax on the income arising from the exercise of the options. This means the employee will not have to pay any taxes on the income until they sell the shares.

Taxation at the time of sale:

When the employee eventually sells the shares, they will be liable to pay tax on the difference between the sale price and the exercise price. The tax rate applicable will depend on the period for which the employee held the shares.

Here’s a breakdown of the two scenarios:

Scenario 1:

• Vesting: Employee pays tax on the difference between fair market value and exercise price at vesting.
• Sale: No further tax liability.

Scenario 2:

• Vesting: No tax liability.
• Sale: Employee pays tax on the difference between sale price and exercise price.