Understanding ESOPs, RSUs & ESPPs
In the current job market, one of the ways employers lure talented and skilled people to join them is by offering ESOPs, RSUs, or ESPPs. All these are basically, different ways of offering company stocks to the employees.
For most senior-level hires, a major part of the compensation is given in as RSU or ESOPs. Even for young professionals, these are offered as a part of their compensation to make a better offer and also to make them stay longer in the company. Many foreign companies also offer these as part of compensation.
However, before you accept any new job offer, you have to clearly understand what ESOPs, RSUs, and ESPPs stand for and check if it’s beneficial for you. If you are working in a foreign company whose stocks are not listed on Indian stock exchanges, it is important to be aware that the tax laws will be different, and also the profit will depend on the currency exchange rate.
Let us try to understand what RSUs, ESOPs, and ESPPs mean, how they work, and how they impact your earnings.
RSUs – Restricted Stock Units
RSUs are stocks of the company given by your employer as part of your compensation. The number of stock units allocated to you per annum as RSUs would be mentioned in your offer letter. There is no cost to be borne by you in acquiring RSUs.
However, there will be time restrictions on the selling of stocks allocated under RSUs. RSUs that are allocated every year, vest in tranches specified by your company. You can sell your stocks only after it vests.
ESOP – Employee Stock Option Plan
Employee Stock Option Plan (ESOP) is a type of employee benefit plan which gives you an ownership interest in the company. In this, you can acquire the shares of the company at a concessional rate at a predetermined price, as compared to the market rate. You are required to purchase
It is one of the most popular ways to encourage you to work for a longer time in the company. Many startups also offer ESOPs as part of the package as they cannot afford to pay you huge salaries.
ESPP – Employee Stock Purchase Plan
ESPP is a tax-efficient way through which employees have the opportunity to purchase stocks of the company they work for at a discounted price. Employees contribute to the plan by way of payroll deductions. These deductions build up between the offer date and the purchase date.
ESPP works like a SIP (Systematic Investment Plan) where employees contribute a part of their salary (say 5 -15%) for a fixed time. Once the period is over and the corpus is accumulated, it can be utilized to purchase the company’s stock. On the purchase date, the company uses the accumulated funds to purchase stocks on behalf of participating employees.
Taxability of RSUs, ESOPs and ESPPs
If you are offered either RSUs or ESOPs or ESPPs as part of your compensation, you should analyze them from two tax angles:
- Taxability when you receive (Income)
Depending on whether you receive either ESOPs or RSUs or ESPPs as compensation, it will be treated as income. However, the calculation of income and the tax applicable to that income will be different for each.
2. Taxability when you sell (Gains)
If you sell your company’s shares, you have to pay capital gains tax on the profit you made. Depending on whether you received it as RSU or ESOP or ESPP, the calculation of gains/profit will be different.
Depending on the holding period, either long term capital gains tax (LTCG) or short-term capital gains tax (STCG) is applicable.
Tax treatment when you receive
Since you would not have paid any amount to acquire your company shares which were received as RSUs, the vesting price i.e. the market value of the shares on the vesting date is considering as income. The income is considered as perquisites and your employer will deduct TDS for this. This income should be shown as income from salary in your tax return.
For example, assume that you receive 10 RSUs on 15th April 2018 which would vest on 15th April 2020. If the market price on 15th April 2020 was Rs.500/- per share, then Rs.5000/- (10 * Rs.500/-) will be treated as income. This would be added to your income and taxed at your Income Tax slab rate. Here Rs.500/- is the vested price and the vesting date is 15th April 2020.
Sometimes, your company might sell a certain portion of your RSUs after vesting, to pay for your applicable taxes. The remaining shares are then transferred to your name.
Tax treatment when you sell
You can sell the shares allotted as RSUs only after they vest. The profit/gain is calculated as the difference between the sale price and the vesting price.
Consider the previous example in which 10 RSUs vests on 15th April 2020 at a market price of Rs.500. Assume that you sell all your shares on 15th Sep 2020 at a price of Rs.600. The gain is calculated to be Rs.100/-(Rs.600 – Rs.500). Here, Rs.600/- is the sale price.
If you sell your shares within one year from the vesting date, it is considered as short-term capital gains (STCG), and STCG tax is applicable. If you sell your shares after one year from the vesting date, it is considered as long-term capital gains (LTCG), and LTCG tax is applicable. This rule applies if your company shares listed in India.
If your company shares are not listed in India, it is considered as an unlisted share, and a holding period of 3 years from the vesting date is considered as long-term, and less than that as short-term.
Below are the tax rates applicable when you sell RSUs:
Tax treatment when you receive
In ESOPs, the difference between the price at which you buy your company’s stock on the exercise date and the market price on that day is treated as income. The income is considered as perquisites and your employer will deduct TDS for this. This income should be shown as income from salary in your tax return.
For example, assume that you have received 10 ESOPs on 15th April 2018 with the option to purchase it on 15th April 2020 at a price of Rs.200/-. Assume that on 15th April 2020, the market price of your company share is Rs.300/-.
In this case, you have to pay Rs.2000/- if you choose to buy the shares on 15th April 2020. However, the market value of 10 shares on that day is Rs.3000/-. The difference between the market price and the exercise price is treated as income. It is added to your income as salary and taxed at the applicable IT slab rate. Here, Rs.200 is the exercise price of the ESOP, and 15th April 2020 is the exercise date of the ESOP.
Tax treatment when you sell
For ESOPs, the profit/gain is the difference between the sale price and the exercise price.
Consider the previous example in which you bought 10 ESOPs on 15th April 2020 at an exercise price of Rs.200/- per share. Assume that you sell these on 20th Sep 2020 when the market price was Rs.600/-. In this case, the gain is calculated to be Rs.400/- (Rs.600 – Rs.200). Here, Rs.600/- is the sale price.
If you sell your shares within one year from the exercise date, it is considered as short-term capital gains (STCG), and STCG tax is applicable. If you sell your shares after one year from the exercise date, it is considered as long-term capital gains (LTCG), and LTCG tax is applicable. This rule applies if your company shares listed in India.
If your company shares are not listed in India, it is considered as an unlisted share and a holding period of 3 years from the exercise date is considered as long-term and less than that as short-term.
Budget 2020 Amendment
From FY 2020-21, if you receive ESOPs from an eligible startup, you need not pay tax in the year you exercise the option. The TDS on the perquisites are deferred to whichever of the following events occurs first:
Tax treatment when you receive
In ESPPs, the difference between the discounted price at which you buy your company’s stock, and the market price on the date you buy the shares, is considered as income.
For example, assume that your company has made an offer on 15th April 2018 that you can buy shares of the company on 15th April 2020 at a price of Rs.200/-. From April 2018 to March 2020, a part of your salary will be deducted to fund the purchase on 15th April 2020. Even if the market of your company’s share is Rs.300/- on 15th April 2020, then you can buy the shares at Rs.200/-. Here, Rs.200 is known as the discounted price and 15th April 2020 is known as the purchase date.
In case you work for a foreign company, the income will be calculated in the above manner for RSUs, ESOPs, and ESPPs. However, the income will be taxed as Foreign Income.
Tax treatment when you sell ESPPs
For ESPPs, the profit/gain is the difference between the sale price and the discounted price at the time of purchase.
Consider the previous example in which you bought shares of your company at a discounted price of Rs.200/- on 15th April 2020. Assume that you sell it on 15th Sep 2020 at the price of Rs.600/-. In this case, the profit is calculated to be Rs.400/- (Rs.600 – Rs.200). Here, Rs.600/- is the sale price.
Benefits of RSUs/ESOPs/ESPPs
- It gives you a chance to create enormous wealth.
- You can buy the stocks of your company, at a lower price than the market price.
- When you own the shares of the company received either through RSUs/ESPPs/ESOPs, you are entitled to dividends and all other rights as a common shareholder.
Risks of RSUs/ESOPs/ESPPs
- There is always a risk of losing the invested capital if the company winds up.
- The share market is exposed to various risks such as economic risk, geo-political risks, etc. which may affect the returns.
- You have to pay taxes when you receive the ESOPs, RSUs, or ESPPs, and also when you sell them.
- You are forced to continue your employment even if you are unwilling until the entire stocks vest. If you leave the company before the stocks vest, you will lose all the unvested stocks which were part of your compensation.
- Your unvested RSUs or un-exercised ESOPs are not considered by any financial institution as your net worth.
- If RSUs are compulsorily given by your employer, you will be forced to take exposure to equity even in the case that your risk appetite is low.
- If your employer is a foreign company, the shares might not be listed in India. In such a case, the holding period is higher as the shares are considered as unlisted.
- If the country in which your company is based does not have a DTAA (Dual Taxation Avoidance Agreement) with India, your profits might attract tax in India as well as in the country in which your company is based.
- If your company is based in a foreign country, the profit you make will be impacted by the currency exchange rate.