Monthly Archives: December 2013

Ways to Save Tax on ESOP sale in unlisted companies

By now you must be aware of the tax liability arising out of sale of ESOPs. If not, you might like to go through the previous blog “Tax treatment of profit from sale of ESOPS of unlisted shares and use the calculator.

I believe TDS is the best mechanism as that way we just see the post-tax amount. However, it is not easy to pay tax after receiving the whole amount in ones account. The good news is that there are legal ways to save tax – this article explores the same and deals with tax avoidance, and not tax evasion.

Option 1Pay Tax and have the right to use the money right away.

This is by far the simplest way if one wants to use the money right away. But this is not why we are here for 🙂

Option 2 – Offset the profits

If there are long term capital losses from other capital assets (except through stocks traded in recognized Stock exchange) the same can be offset by the profits earned.

The gain can also be offset against any short-term capital loss (including stocks traded on recognized stock exchange). Even if this loss has occurred in any of the past 8 years such loss can be used to offset the long term gains that have resulted from ESOP sale (provided the returns were filed in time, loss mentioned and not setoff yet against any other capital gain). This shall bring down the tax liability or may even nullify it.

Option 3 – Invest the profit in bonds under Section 54EC of Income Tax Act

The extent of profits invested in 54EC bonds issued by NHAI and REC is exempt from tax. Let’s take an example – Suppose Amit sells ESOPs in DreamCompany for INR 3,00,000 and earns a profit of INR 2,00,000 in this transaction. If Amit invests this amount of INR 2,00,000 in 54EC bonds then he shall not have to pay any tax. The exemption is capped by the amount invested in bonds and for remaining amount the tax liability remains as is. So if Amit invests INR 1,50,000 then his tax liability is reduced by this amount and remains INR 50,000. What’s the catch then?

i)                    54EC bonds have a lock-in period of 3 years – one cannot redeem, sell or obtain loan against these bonds.

ii)                   Rate of interest on these bonds is 6% paid annually and this interest is taxable; which translates to 4.15%, 4.76% and 5.39% post tax return for an individual in 30%, 20% and 10% tax bracket respectively.

iii)                 After 3 years the bonds are encashed and there is no tax on the amount received (which is same as that invested initially)

iv)                 The maximum amount of bonds that can brought is capped at INR 50,00,000 per Financial Year

There are certain rules that need to be adhered to while choosing this instrument for tax saving though

i)                    The bonds must be purchased within 6 months of sale of asset or last date of filing the tax return whichever is earlier.

ii)                   If the bonds are sold during 3 years of lock-in, the whole amount is considered LTCG for that year and taxed accordingly.

Option 4 – Invest the sale proceeds in a residential property under section 54F of Income Tax Act

This option is available only if the individual has no more than one residential property in his/her name i.e. if someone already have 2 or more residential properties in his/her name, he/she cannot avail this option. Another catch here is that whole proceeds from sale need to be invested in order to claim 100% tax rebate. So in our example earlier, Amit needs to buy residential property worth INR 3,00,000 or more in order to save 100% tax. If Amit decides to buy a property worth less than INR 3,00,000 then the rebate available is calculated as below.

Tax rebate = (Profit_from_sale * Cost_of_new_property) / Sale_proceeds

So if Amit decides to buy a property worth INR 1,20,000, he shall be eligible for

Tax rebate = (2,00,000 * 1,20,000)/3,00,000  = INR 80,000

Following are the rules governing this act

i)                    The new property must be brought within 1 year before the date of transfer of original asset to 2 years after the date of transfer. In case the property is being constructed the time limit is upto 3 years after the date of transfer.

ii)                   The new property cannot be sold within 3 years of purchase. In case it is sold the entire amount becomes taxable in that year.

iii)                 The individual cannot buy another residential property with 2 years of transfer of original asset (ESOPs in this case) or construct one within 3 years of transfer of original asset.

The drawback of article 54F is that to avail complete rebate, full amount needs to be invested thereby leaving no cash for immediate use.

The above transaction needs to be completed by the time return is filed. An instant question that comes in that case is – How is it possible to complete the transaction by the time of filing the return when the time limit available is 2 years and 3 years respectively for purchasing or constructing a new house? Well for the same a facility of Capital Gain Accounts Scheme (CGAS) is available. If the individual is not able to buy a house by the date of filing the tax return, the amount must be parked in a CGAS account. This account can be opened with specified nationalize banks and are for the sole purpose of parking funds till appropriate property is finalized. However, the full amount shall become taxable when the time is over and the property is not bought.

So what are you thinking? Go ahead and choose the option that best suits you. In case you have any queries, feel free to comment or send those to fintelligenceindia@gmail.com

Stay tuned for the next blog

How to best utilize a windfall?

Disclaimer – This article is for information purposes and should not be treated as legal advice.

References

http://taxmantra.com/faq-on-capital-gains-tax-and-capital-gains-exemption.html/
http://taxmantra.com/capital-gains-arising-longterm-capital-asset-house-property-exempted-54f.html/
http://law.incometaxindia.gov.in/Directtaxlaws/act2005/sec_054.htm
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Congratulations!! You are here so it’s most likely that you either cashed out your options/shares or are holding some and expecting those to be bought out soon. In any case, my heartiest congratulations to you!!

This article deals with the tax treatment on profits arising out of sale of either ESOPS or shares held in a privately held company – a company not traded on recognized stock exchange.

Let us consider an example and look at various scenarios to understand tax treatment on various types of proceeds – Let us assume that Amit works in the Indian subsidiary of a company called DreamCompany (a US based multinational) and has been granted options as per the table below. It is assumed that the vesting schedule is monthly proportionate basis in 4 years (i.e. every month 1/48 of the granted options vest).

Number of Options Options grant date Exercise Price Number of Options exercised Option exercise date Exchange rate Fair Market Value (FMV) as of exercise date
Scenario 1 1000 1st April 2005 USD 0.20 1000 15th June 2009 47.50 USD 1.04 = INR 49.40
Scenario 2 1000 1st April 2007 USD 0.55 1000 30th July, 2013 58.29 USD 2.85 = INR 166.13
Scenario 3 1000 1st April 2011 USD 1.85 1000 N/A N/A N/A

Let’s also assume that on 1st Dec 2013 the DreamCompany gets acquired by another company which agrees to pay USD 3.85 for each share and option of DreamCompany. Let us visit Amit’s tax liability in the above scenario. Let’s also assume that by the time Amit get’s the amount credited to his account (say 10th Dec, 2013), the exchange rate between USD and INR is 60.83.

Scenario 1 – When Amit exercised his vested options on 15th June, 2009, he would have paid the company a sum of INR 9,500 (Number_of_options * exercise_price * exchange_rate = 1000 * 0.20 * 47.50). He would have also paid the taxes on the difference between this amount and the Fair Market Value of the stocks = INR 49,400 (Number_of_options * FMV * exchange_rate = 1000 * 1.04 * 47.50). Tax would have been paid on INR 39,900 (FMV – exercise_price = 49,400 – 9,500). The acquisition price of the 1000 stocks in DreamCompany for Amit in this case becomes the FMV on 15th June, 2009 i.e. INR 49,400. The sale proceeds that Amit is entitled to is INR 2,34,195 (Number_of_shares * acquisition_price * exchange_rate = 1000 * 3.85 * 60.83). As the date of acquisition (15th June, 2009) is older than 12 months from the date of sale (10th Dec, 2013), this shall be considered a Long Term Capital Gain (LTCG).

LTCG Tax on such transaction is 20% of the LTCG which is arrived at by deducting ‘indexed cost of acquisition’ from the sale proceeds.

To calculate Indexed cost of acquisition, cost inflation index (CII) for Financial Year of Purchase (FY 2009-10 in this case) and CII for FY of sale (FY 2013-14) needs to be determined and used in formula (CII_of_sale_year / CII_of_purchase_year) * purchase_price. For our example this works out to be

Indexed cost of purchase = (929/632) * 49400 = INR 72615

Thus the profit for Amit on this transaction is INR 1,61,580 (sale proceeds – acquisition cost = INR 2,34,195 – INR 72,615)

And LTCG Tax = 20% of INR 1,61,580 = INR 32,316

With Cess of 3% this comes out to INR 33,286

Note – a surcharge of 10% on income tax is levied and thereafter 3% cess levied on whole amount if income exceeds 1 Cr

Scenario 2 – When Amit exercised his vested options on 30th July 2013, he would have paid the company a sum of INR 32,059.50 (Number_of_options * exercise_price * exchange_rate = 1000 * 0.55 * 58.29). He would have paid the taxes on the difference between this amount and the Fair Market Value of the stocks = INR 1,66,126.50 (Number_of_options * FMV * exchange_rate = 1000 * 2.85 * 58.29). Tax would have been paid on INR 1,34,067 (FMV – exercise_price = 1,66,126.50 – 32,059.50). The acquisition price of the 1000 stocks in DreamCompany for Amit in this case becomes the FMV on 30th July, 2013 i.e. INR 1,66,126.50. The sale proceeds that Amit is entitled to is INR 2,34,195 (Number_of_shares * acquisition_price * exchange_rate = 1000 * 3.85 * 60.83). As the period of holding has been less than 12 months (July 2013 to December 2013) this is considered as Short Term Capital Gain and added to the total income of the individual for that FY and is thus taxed at the rate of 10%, 20% or 30% as the case may be.

Scenario 3 –  Amit holds options that are still vesting. Out of 1000 allotted on 1st April 2011, 667 options would have vested. Depending on the type of acquisition company might or might not buy out the options. In case options are bought by the company the income arising is considered as Short Term Capital Gain and added to the total income of the individual. Here as there has been no investment from individual’s end, individual is entitled to the difference of the acquisition price and exercise price. So in our example, Amit made a profit of INR 81,147 (Number_of_vested_options * (acquisition_price – exercise_price) * exchange_rate = 667 * (3.85 – 1.85) * 60.83)

ESOPs Capital Gains Calculator

Upcoming blogs in this series –

–          Ways to Save Tax on ESOP sale in unlisted companies

–          How to best utilize the windfall?

DisclaimerThis article is for information purposes and should not be treated as legal advice.

References

http://cadiary.org/cost-inflation-index-capital-gain/ – CII table

Practical approach to Income Tax by Girish Ahuja and Ravi Gupta

http://www.moneycontrol.com/news/tax/confused-about-taxesincomeshares-heres-help_973559.html