Bleeding shares of start-ups call for review of ESOP taxation policy

With market prices of listed start-ups down in the dumps, there is a case for reviewing the taxation structure of the employee stock ownership plan (ESOP) in the Budget for 2023-24.

The market price of Nykaa was down 86.6 per cent at Rs 150.55 as on Monday, compared to the issue price of Rs 1,125, while that of Paytm was down 76.6 per cent at Rs 503.8. Similarly, investors in Zomato, Delhivery and Policybazaar have lost their money.

This has led to a situation where those having ESOPs are facing huge capital losses. Currently, ESOPS are taxed at two stages -- one as perquisites at the time of getting shares and another as capital gains at the time of the sale of the shares.

Companies generally deduct the tax payable at the time of allotment of shares by adding the income from ESOPs to employees' income as personal income tax. The rate depends on the slab -- 10, 20 or 30 per cent plus cess and surcharge-- that the employee would fit in.

Suppose the fair market value of shares is Rs 10,000 crore and employees get it at Rs 6,000 crore, then Rs 4,000 crore would be added to the income of the employee and taxed as per the slab of the employee.

Now the shares are also taxed as capital gains when the employee sells the shares. Listed shares are taxed at 10 per cent for long-term capital gains, if the gains are more than Rs 1 lakh.

However, in most cases as seen above, investors are making losses. For those having ESOPs, the losses would be different from those who got it through IPO because employees get it at exercise price and not IPO price. These losses could be carried forward for taxes on capital gains in other areas for eight years. However, salaried people may not have any capital gains to carry the losses forward.

This has created a losing situation for employees.

The Finance Act, 2000 did give some relaxation to start-ups. But these are given for those which have registered with the Department for Promotion of Industry and Internal Trade (DPIIT) by March, 2021. The relaxation is that the tax at the first stage can be collected after four years or when the employee leaves or if these shares are sold.

However, Hitesh Sawhney, partner at PWC said the relaxation is very limited since it is only for DPIIT registered companies and that too when they have registered by March 2021. Besides, employees may choose to sell the shares after four years which means that they have to pay the tax after four years which will again create the same problem.

He suggested that since start-ups retain talent by giving them ESOPS, the stock option be taxed at the time of selling the shares and that too under the head salary and not capital gains. So, even if the employee may incur loss, the government will get tax that will avoid the need of preponing the tax at the time of allocating it.

Experts said the present-day tax treatment is usually found in anti-avoidance provisions. However, ESOPs have never been used as a tax avoidance strategy and the present tax treatment without accrual of any real income in the hands of the employees may seem unreasonable, they added.

Sandeep Sehgal, partner tax, at AKM Global, said this is a scenario where the present scheme of taxation of ESOPs is detrimental to the employees.

"The scheme assumes an upward trend in the valuation of the company, which is not very logical and the employee may end up paying tax on higher valuation but would end up paying tax on higher valuation if the prices fall after the listing," he said.

Hence, this calls for a review of the existing scheme of taxation and a more rational basis should be designed for the same, Sehgal said.