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)
Upcoming blogs in this series –
– How to best utilize the windfall?
Disclaimer – This article is for information purposes and should not be treated as legal advice.
Practical approach to Income Tax by Girish Ahuja and Ravi Gupta