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.



5 thoughts on “Ways to Save Tax on ESOP sale in unlisted companies

  1. Pankaj

    Hi Sajal,

    Thanks for your blog. It does help in understanding many complex laws in simple language. I would want to know further tax benefits that I can avail on the new asset.

    Currently I work in Gurgaon. I have a residential house in Ghaziabad with full house loan paid. I had claimed tax benefit on the house loan. Now I am planning to purchase new residential house from the long term capital gain (full sale proceeds) + house loan in Jaipur.

    Case 1: I self occupy Ghaziabad house.
    Can I claim tax benefit on EMI interest paid to banks on Jaipur house? If there is rental income from the Jaipur house, how is that to be treated?

    Case 2: I stay in a rented house at Gurgaon
    Can I claim HRA benefit on rent paid along with tax benefit on EMI interest paid to banks on Jaipur house? If there is rental income from the Jaipur house, how is that to be treated? If there is rental income from the Ghaziabad house as well, how is that to be treated?

    Thanks in advance for your reply

    1. fintelligenceindia Post author

      Congrats Pankaj!! I must say you are planning good.

      Case 1 – Yes you can claim tax benefit on interest paid on the loan amount. In case of rental income, the income shall be computed by first deducting any municipal taxes paid from the annual rent receipt, post that a standard deduction of 30% is applied (under Section 24). From this amount interest in deducted (complete interest with no upper cap) and the final amount is accounted for under ‘Income from House Property’ while filing Income Tax

      Case 2 – Given your residential house is at a substantial distance from your office, yes you can stay at rented house and claim HRA. Rent from Jaipur shall be treated as in case 1 above. For Ghaziabad house – You can deduct Municipal taxes from that and avail 30% deduction. As there is no loan on that, the amount shall be added to ‘Income from House Property’. Now the most interesting part. If your interest outgo from Jaipur EMI makes the income from Jaipur in negative, the same can be setoff against income from Gzb property.

      My recommendation – Case 2 as you get HRA benefit as well as opt for a bigger house in Jaipur with substantial EMI component and save tax on that as well.

      Hope this helps.

  2. Amit

    Hey Sajal,

    I must say information on your blog proved to be very handy both in terms of understanding and executing the tax calculations and tax saving mechanisms.

    I would also like to thank you for your prompt reply to my specific query over email.

    Wish you all the best,

  3. Uttiya

    Hi Sajal,

    Guess I am a little late to the party but a great read nevertheless.

    Had one quick query and probably a stupid one. Does repayment/foreclosure of a Home loan exempt one from paying capital gains tax??

    1. fintelligenceindia Post author

      Hi Uttiya,

      Thank you for the kind words.

      Repayment/foreclosure of a home loan does exempt one from paying Capital Gains Tax provided the condition on the timeline of buying the property is met i.e. the property for which home loan is being foreclosed/repaid has been bought within 1 year before the date of transfer of original asset.

      Let me know of any further query


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