Budget 2020 announces 5-years tax holiday on tax on ESOPs

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Giving a big boost to startups, the union budget for the financial year 2020-21 tabled by finance minister Nirmala Sitharaman proposed to defer payment of tax on ESOPs (Employee Stock Option Plan) by five years, or till employees leave the company or sell their shares, whichever is earlier.

During the budget speech, the finance minister said, “during their formative years, startups generally use ESOPs to attract and retain highly talented employees. ESOPs are a significant component for compensation of these employees. Currently, ESOPs are taxable. This leads to a cash flow problem for the employees who do not sell their shares immediately and continue to hold them for a long term,” she said.

At present, the ESOPs are taxed at the time of exercise, that means when an employee chose to purchase them. The tax is calculated on the difference between the market price of the share and the exercise price, which is always lower than the market price. The tax is deducted as TDS by the employer at the time of exercise.

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Later when the employees choose to sell the share, they are again required to pay capital gain tax on profit made on such selling. The startup community had contended that this amounts to double taxation on the same shares, and they were demanding that the tax rules on ESOPs should be taxed. All industry bodies such as NASSCOM, Ispirt, Indiatech, IVCA and others had been asking for a change in the taxation of ESOPs.

Now Employees will not have to pay tax on ESOP at the time of allotment. They will have to pay the tax only 5 years after exercising the ESOP option. But if the employees leave the company or sell their shares before 5 years, then they will have to pay tax at that time.

The finance minister said that startups have emerged as an engine of growth for India’s economy and over the past year, the government has taken several measures to handhold them and support their growth.

Welcoming the relief provided the budget to the startups, Snapdeal CEO and co-founder Kunal Bahl tweeted, “ESOP tax reform is here. Big win for the startup ecosystem!”

Earlier on January 13, Kunal had made two demands from the startup and angel ecosystem, ESOPs should be taxed at the point of liquidity, not exercise, and sale of unlisted equities should be taxed at the same rates as listed equities. And his first wish was fulfilled in the budget.

The finance minister also proposed a 100% deduction of profits for startups with turnover upto Rs 25 crore for three consecutive years in a period of 7 years. Moreover, the finance minister also proposed to increase the turnover limit for tax exemption for larger startups from existing Rs 25 crore to Rs 100 crore.

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