Understanding RSU, ESOPs, ESPP & tax implications

Here are a few points that would help in Understanding RSUs, ESOPs, ESPPs & its tax implications:

Understanding RSUs, ESOPs, ESPPs & its tax implications

Most employers these days, offer compensation packages which include various breakups like basic, Special allowance, EPF contribution, gratuity contribution, variable salary, ESOPs, RSUs, etc. Such packages offered are usually referred to as “CTC – Cost to Company”.

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Prospective employers include RSUs or ESOPs in the CTC to attract & retain talent. However, many job seekers accept such packages, without understanding its worth or tax implications.

Let us try to understand what RSUs, ESOPs and ESPPs mean, how they work, and how they impact your earnings.

Restricted Stock Units (RSUs)

RSUs are stocks of the employer, given to you as mentioned in your compensation letter, without any contribution from you. However, such allotment of shares come with certain restrictions, on the timeframe to sell the same.

How do RSUs work?

Assume you join a company on 1st April 2017, and you get 100 RSUs allotted to you on 10th April 2017. If the company specifies that the RSUs vest in 4 tranches of 25% each for 4 years, then on 10th April 2018, the 1st tranche of 25 stocks is available for you to sell/hold. Then, on 10th April of the following years, 2019, 2020 and 2021, the remaining RSUs vest at 25 stocks each.

The date, on which the shares are allotted to you is called as the grant date. Though the shares are granted to you, you cannot sell them immediately. Every year, a certain percentage of the stocks (also known as tranches), become eligible to be sold. It is called Vesting of the shares, the price of the stock on that day is called vesting price, and the date is called vesting date. On vesting, you can either continue to hold the stocks or sell it.

Employee Stock Option Plan (ESOPs)

ESOPs are also stock-sharing plan with employees; however, the stocks are not given to the employees immediately. You are given an ‘option’ to purchase the shares of your company, at a future date at a predetermined price.

How do ESOPs work?

E.g. Assume you join a company on 1st April 2017, your firm gives you the option to purchase 100 stocks on 1st Oct 2018, at a price of Rs.200. So, on 1st Oct 2018, you have to buy the stock at a committed price of Rs.200, irrespective of the stock price at that time. This transaction may either make you a profit or loss, depending on the share price at that point.

The date, such option is given to you is called the ‘grant date’. And the date for which you are eligible to exercise the option is referred to as the ‘exercise date’ and the price of the stock, on that day is called ‘exercise price’. Such purchased stocks, also have restrictions on the selling timeframe. Every year, a certain percentage of the stocks (also known as tranches) become eligible to be sold.

Employee Stock Purchase Plan (ESPP)

In this, a discount is given on the market price, to the employee to purchase company shares. The company usually opens 2-3 windows per year, for you to purchase company stocks. You can purchase the company stocks from a part of your salary (usually around 10%-15%), at a discounted price.

E.g. Assume you are contributing 10% of your salary every month for purchasing company stocks. If the purchase window opens, twice a year, then all the accumulated money from your salary will be used to buy the company stocks, after an applicable fixed discount, at the lowest price of the stock between two purchase windows.

It is like investing in any other stocks in the stock market, except that you get to buy it at a price less than the market price. Here, you have to spend money from your pocket to invest. The gain/profit made are subject to typical risks, which are faced by the stock market.

Taxability of RSUs, ESOPs and ESPPs

Tax on the income

RSUs – Since, no amount if paid by the employee to acquire the company shares, the market value of the shares on the date of vesting, is considered as income.

ESOPs – Since in ESOPs, you buy the company shares at a predetermined price, the difference between the price at which you exercise your stock option, and the market price on that day, is considered as income.

ESPPs – Since in ESPPs, the discount is given on purchase of company stocks, the difference between the discounted price, and the market price on the purchase date, is considered as income.

The income derived from ESOPs and ESPPs are considered as perquisites and taxed accordingly. The income from RSUs should be declared as Other Income. In case you work for a foreign company, the income is treated as a foreign income.

Tax on the capital gains

On the sale of RSUs, ESOPs and ESPPs, the gains/profit made are subject to capital gains tax. Depending on the holding period of the stock, either long term capital gains tax or short-term capital gains tax is applicable.

For RSUs, the profit/gain is the difference between the sale price and the vesting price.

For ESOPs, the profit/gain is the difference between the sale price and the exercise price.

For ESPPs, the profit/gain is the difference between the sale price and the market price, at the time of purchase.

Also read: Income tax return (ITR) forms for A.Y 2017-18

Applicable Tax Rates

The tax rates vary depending on, whether the shares are a listed/an unlisted company. Listed companies are those that are listed on Indian stock exchanges. Unlisted shares are those which are not listed on Indian stock exchanges, irrespective of whether they are listed on stock exchanges abroad or not.

If you work for a foreign company, whose shares are listed on NYSE or FTSE but not on Indian exchanges, then the stocks are considered as unlisted. Since the unlisted shares are not subject to STT (Security Transaction Tax), the tax rates are different from that of listed shares.

The tax rates applicable for gains from unlisted/listed shares are detailed below.

Understanding RSUs, ESOPs, ESPPs & its tax implications

Benefits and Risks

Like any other component of a compensation package, such perks come with its own set of rewards and risks.

Benefits of RSUs/ESOPs/ESPPs

1. Potential to earn high amounts and create enormous wealth.
2. Since only a part of your earnings in exposed to equity, you won’t be losing your entire earnings.
3. You can get to buy stocks of your company, at a lower price than the market price.

Risks of RSUs/ESOPs/ESPPs

1. The possibility of the share value, reducing to zero if your company winds up.
2. The stocks are exposed to various risks such as economic risks, geopolitical risks, etc., and hence, the returns are also volatile.
3. In ESOPs and ESPPs, the difference between the purchase price and the market price is treated as income and taxed.
4. You have to stay in the company, till the entire stocks vest. If you leave the company, you will lose all the unvested stocks, which were part of your compensation.
5. In the case of RSUs, though it is income in actuality, most banks do not consider it, to determine your loan eligibility, as it does not reflect in your net salary.
6. Having RSUs or ESOPs, may not give you liquidity when needed, as you have to wait for the shares to vest.
7. If you risk appetite is low, and do not wish to diversify to equities, you would have to take exposure to equity, unwillingly.
8. In the case of ESOPs, if you do not have enough money at hand, to exercise your option, you will lose the opportunity to make a benefit.

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Final Words

Benefits like RSUs, ESOPs and ESPPs, constitute a sizeable part of your CTC these days. Before you accept any offer from a company, it is important to evaluate, how will it fit into your long-term financial goals, and your immediate income needs.

Here are some pointers to evaluate, and decide whether to opt for RSUs, ESOPs and ESPPs.

1. If you are young and just started your first job, you can consider an offer with such benefits. At lower levels, the percentage of such benefits will usually be, lower. You can also, take higher risk and also, hold the stocks for the longer term.

2. If you have any major financial goal approaching and need liquidity, it is better to opt for a package with higher take-home pay, rather than such benefits.

3. If you plan to raise a loan shortly, it is better to have a larger amount on your payslip, rather than receiving ESOPs or RSUs.

4. If you are getting closer to your retirement goal, it makes sense to have a lesser percentage of your compensation as RSUs/ESOPs. In case, you decide to retire; you may lose all the stocks allotted if it has not yet vested.

5. If you are middle-aged and have another 15-20 years to retirement, you can consider opting for RSUs/ESOPs at moderate levels.

6. If you are not sure of staying with the company for a long term, then it is best to avoid such benefits, as you will lose the benefits anyway.

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  • Mohit Bansal says:

    Hi,

    I’ve both RSU and ESPP of foreign company.
    When I sell my ESPP. Wil i be taxed on FIFO basis or only on ESPP.
    On etrade we have option to sell only ESPP or only RSU

    e.g.
    20 ESPP shares vested on 1 Jan 2017
    20 RSU vested on 30 Mar 2017
    20 ESPP shares vested on 30June 2017
    20 RSU vested on 30 Oct 2017

    Now when i sell 40 ESPP share on 1Nov 2017. Should i pay tax on [40 ESPP] or [20 ESPP and 20RSU]

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