Budget 2020: ESOP tax deferment for startups fails to excite

The first impression to finance minister Nirmala Sitharaman’s Budget proposal to allow deferment of ESOPs taxation was that it was a big win for the startup economy. But industry members and experts now have flagged newer concerns.

In her budget speech, Sitharaman announced that the taxation on ESOPs for employees would be deferred from the time of exercise to up to five years or till they leave the company or when they sell their shares, whichever is earlier.

Firstly, this new announcement only applies to startups incorporated after April 2016, as per the fine print in the finance bill. The Finance Bill states that this applies to employees of the companies, which qualify as eligible startups under section 80-IAC. To be eligible under Section 80-IAC, startups have to get a certificate from an inter-ministerial board.

This provision, industry members said, will leave out a large section of the startup economy from the jurisdiction of the new rules. While there are close to 28,000 startups recognised by the DPIIT, the number of startups certified by an inter-ministerial board are far fewer at about 200, as per industry members.

“This benefit seems to be extended to only startups incorporated after April 1, 2016. Needs to be extended to all startups that are eligible for the angel tax benefit. Also, need to make ESOPs taxable at sale without the 2 other conditions of 5 years or employee exit,” tweeted Sachin Taparia, founder of LocalCircles, highlighting the second bone of contention for the sector with respect to the budget announcement.

Startups were hoping for a removal of double taxation and wanted ESOPs to be taxed only at the time of sale. This, however, has not changed, with the finance minister only announcing a deferment of the taxation from the time of exercise.

“Currently, ESOPs are taxable as perquisites at the time of exercise. This leads to a cash-flow problem for the employees who do not sell the shares immediately and continue to hold the same for the long term. In order to give a boost to the start-up ecosystem, I propose to ease the burden of taxation on the employees by deferring the tax payment by five years or till they leave the company or when they sell their shares, whichever is earliest,” FM Nirmala Sitharaman said in her budget speech.

A closer look at the fine print seems to have taken the air out of the initial celebratory reactions that we saw from the ecosystem.

Immediately after the Budget speech, there was a barrage of tweets and reactions welcoming the move.

Kunal Bahl, CEO and Co-founder, Snapdeal had tweeted  –  “ESOP tax reform is here. Big win for the startup ecosystem!”

Rehan Yar Khan of Orios Venture Partners had tweeted: “ESOPS: Tax at the time of sale or at end of 5 years or when an employee leaves startup. Whichever 1st. Removes the double tax on ESOPs. Solves a key issue for startups attracting quality talent.”

Khan, however, said he has changed his views after a deeper look.

“It’s not as big a boost as we thought it was. They have not removed double taxation and have only deferred it by five years. This means that even if the company shuts down in those five years or if the share value falls, the employee still has to pay the tax. This is not what we had asked for,” Khan told CNBC TV 18.

Siddarth Pai, managing partner, 3One4Capital said entrepreneurs and investors are “dismayed” with the announcement.

“We are dismayed that the Esop announcement will be applicable only to startups recognized by the interministerial board, which is only a small cadre in the startup economy. The amendment also does not alter the tax regime for startups but only defers the taxation on the exercise of the shares,” he said.

“The superrich tax surcharge also continues to stay on for unlisted shares compared to listed shares,” he added.

Here’s what the fine print on ESOPS says:

The Finance Bill describe 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.”.

Leave a Reply

Your email address will not be published. Required fields are marked *