In India, stock options and equity-based compensation are taxed at two main stages: at the time of exercise and at the time of sale. When employees exercise stock options, they are required to pay tax on the difference between the exercise price and the market price of the shares on the exercise date. Later, when the shares are sold, any profit made from the sale is subject to capital gains tax. The taxation treatment depends on whether the shares are held for the short term or long term.

What Are Stock Options and Equity-Based Compensation?

Stock options and equity-based compensation are forms of employee benefits where companies provide employees with the right to purchase company shares at a fixed price, often lower than the market value. These plans allow employees to benefit from the company’s growth by offering them ownership or the potential for profit if the stock price rises. Some common forms include Employee Stock Option Plans (ESOPs), restricted stock units (RSUs), and stock appreciation rights (SARs).

Tax Treatment of Stock Options and Equity-Based Compensation

The tax treatment of stock options and equity-based compensation in India is divided into two stages: taxation at the time of exercise and taxation when the shares are sold. Upon exercise, the difference between the exercise price and the market price of the shares is considered a perquisite (a taxable benefit) and is taxed as salary income. This amount is subject to income tax based on the employee's applicable tax slab.

Taxation on Exercise of Stock Options

When you exercise stock options, the difference between the exercise price (price paid by the employee) and the market price (the price on the exercise date) is treated as a taxable benefit and taxed as income under the head "Salary." For example, if the exercise price is ₹100 and the market price is ₹200, the ₹100 difference will be taxed as salary income. This amount is subject to the individual's income tax rate.

Capital Gains Tax on Sale of Shares After Exercising Options

After exercising the stock options and holding the shares, any profit made when selling the shares will be taxed as capital gains. If you sell the shares within 24 months of exercise, the profit is considered short-term capital gains (STCG), which is taxed at 15%. If the shares are sold after 24 months, the profit qualifies as long-term capital gains (LTCG), which is taxed at 10% if the gains exceed ₹1 lakh in a financial year.

Tax Treatment of Restricted Stock Units (RSUs)

In the case of Restricted Stock Units (RSUs), tax is applied when the shares are vested and converted into actual shares. At the time of vesting, the market value of the shares is treated as income and is taxed as salary. Any further gain made from selling the shares is treated as capital gains, either short-term or long-term, depending on the holding period after the shares are sold.

How Is the Cost of Acquisition Calculated for Stock Options?

The cost of acquisition for stock options is generally the exercise price paid by the employee. If there was any perquisite tax paid at the time of exercise, this amount can be added to the cost of acquisition for calculating capital gains tax when the shares are sold. This ensures that the employee only pays tax on the actual profit made from the sale of the shares, taking into account the total cost incurred.