Income Tax implications of Stock Options

What do you mean by a ‘Stock Option’?

A stock option is a privilege transferred by one person to another which provides the buyer the right, to buy or sell a stock (ordinary shares) at a settled price within a period of time. It is generally a part of executive package.

Purpose:

Corporate houses often take the help of special incentive policies to reward their employees for their remarkable performance in order to boost their possibilities of long-term association with the company. One of such incentive policies is employee stock option plan.

Taxability of stock options would depend on length of period employee holds the share, Status of the Company issuing Stock Options and whether the share issue was made at Arm’s length pricing principle

Such benefits are a part of the employee’s salary income and they are taxable like other perquisites. The perquisite value is calculated as the excess of the fair-market value of the share on the exercise price.

There are some rules of valuation prescribed for all the companies to determine the fair-market value. The employer has to withhold tax at source for such a perquisite.

Kinds of stock options:

American Stock Options comprise most of the public exchange-traded stock options which can be exercised by an employee any time between the date of purchase and the date of expiry.

On the other hand, European Stock Options or the ‘share options’ are less common options and can only be redeemed after the date of expiry of the option.

Taxation of such benefits:

The consequences of exercising the option depend upon whether the company providing it is a private corporation, the period of time the employee holds them before selling and whether the employee is at arm’s- length with the corporate body providing it.

The first event of tax ability arises on the date of transfer of such shares in the name of the employee. The benefit arising which is actually difference between the Fair Market Value on the date on which it is exercised and the amount actually paid or recovered and the same is subject to tax as a part of the salary income of the employee.

An employer has to compute the benefit which includes the same as part of the salary income and has to recover the tax from the employee.

The process of determining the value differs for shares that are listed on a recognized stock exchange. However shares that are not listed on a recognized stock exchange are also determined.

If the shares of a company are listed on a recognized stock exchange, the fair market value has to be determined as the mean between the opening price and the closing price of the share.

If the shares are not listed, the fair market value has to be determined by a banker which is registered with the Securities and Exchange Board of India on a date which is either the date of exercising of the option or any date before the date of exercising of the option. However the date should not be more than 180 days prior to the date of exercise.

The second event of tax ability of stock options arises in case of sale or transfer of shares. The difference between the consideration of sale and the fair market value is be treated as capital gains and is subject to capital gains tax.

The capital gains are either long term or short term, depending upon the period of their holding.

There is no explanation on the taxability of such benefit for globally mobile employees. The rules do not explain the taxability of non-residents or those who are not ordinarily resident in India and people who have worked overseas during the period. An analogy on such issues can only be drawn only from the instructions provided by the Central Board of Direct Taxes.

Also read:

Income from stocks—business income or capital gains