Startups demand via LocalCircles that ESOP benefit announced in Budget 2020 be made available to all DPIIT registered startups
- • Benefit announced currently only applicable to startups that have Inter Ministerial Board certification i.e. under 80-IAC whose number is less the 250
- • In the current form ESOP taxation benefit won’t be available to 99.5% of startups
- • Startups willing to provide a declaration similar to angel tax as additional validation
February 3, 2020, New Delhi: ESOPs are an integral part of the startup ecosystem and help them in hiring good talent, but ESOP taxation has been a challenge for startups and its employees as the Government regulations mandated that ESOPs be taxed at the date of exercise. In the pre-budget meet held in December 2019, LocalCircles which represented the startup community had brought up the issue of ESOP taxation to the attention of the Finance Minister requesting that ESOPs be made taxable at the point of sale.
When presenting Budget 2020, the Finance Minister announced that ESOPs will now become taxable at the earliest event amongst 1) Date of Sale of Shares, 2) Employee’s exit from the company and 3) 5 year period after the shares were exercised.
The Finance Bill however describes the amendment to Section 156 of the Income-tax as such - Where the income of the assessee of any assessment year, beginning on or after the 1st day of April 2021, includes income of the nature specified in clause (vi) of sub-section (2) of section 17 and such specified security or sweat equity shares referred to in the said clause are allotted or transferred directly or indirectly by the current employer, being an eligible start-up referred to in section 80-IAC, the tax or interest on such income included in the notice of demand referred to in sub-section (1)shall be payable by the assessee within fourteen days––(i) after the expiry of forty-eight months from the end of the relevant assessment year; or(ii) from the date of the sale of such specified security or sweat equity share by the assessee; or45 (iii) from the date of the assessee ceasing to be the employee of the employer who allotted or transferred him such specified security or sweat equity share, whichever is the earliest.
If we go by the section 80-IAC (as mentioned in the Budget 2020 document), less than 250 startups operating in the country that are recognised by the (Inter-Ministerial Board), will be eligible for this benefit. India currently has approximately 50,000 startups and approximately 27,000 are registered under DPIIT Startup India program. This would mean that 99.5% of the Indian startups will not be able to avail of the ESOP benefit announced in budget 2020.
In addition, the two additional conditions that make ESOP taxable i.e. 5 years after the exercise date or exit of an employee from the company will only complicate matters. For instance, if an employee exercises shares and holds them and the sale event does not take place in the 48 month period, the employee will be liable to start paying taxes on paper gain in value of shares. Startup valuation is subject to change and in case the value of the shares goes down in future or the startup shuts down, the employee would have already have paid taxes. Similarly, if an employee of startup A leaves to join startup B after a 5 year period, they either have to exercise and pay taxes on their shareholding of startup A and hold those shares or simply leave their vested shares.
LocalCircles, after consultation with startups and entrepreneurs on its platform recommends the following to the Finance Minister:
- 1) ESOP taxation at date of sale be extended to all DPIIT i.e. Startup India registered startup. In the event an additional validation or declaration is needed like the angel tax declaration, the same may be instituted
- 2) The criteria for ESOP taxation be kept as date of sale and the other two conditions of making ESOP taxable i.e. 5 years after the exercise date or exit of an employee from the company be removed
With these in place, not only will most startups be able to benefit from the ESOP tax relaxation announced in Budget 2020, they will be able to utilise the ESOP benefit more effectively to attract and retain talent. On the employee front, many more startup employees will be able to have faith in this benefit offered by startups and realise it in reality versus only on paper. More ESOP income by startup employees does mean more direct tax collection for the Government.