As the Finance Minister is all set to present the union budget on February 1. Multiple wishlists have been making their way, calling for tweaks in GST norms, policies to ensure growth momentum is maintained and so on.
The budget is a crucial event for the startup ecosystem, as it provides insight into the government's policy on Employee Stock Ownership Plans (ESOPs) and potential changes to the banking system. To support the growth of startups and small businesses, we hope the Finance Minister takes steps to address issues such as hefty pre-closure charges imposed by banks and high stamp duty rates for business loans.
These rates can be detrimental to the growth and success of startups and small businesses. To support the startup ecosystem, we hope the Finance Minister considers waiving these charges for startups and MSMEs in the upcoming budget. This would provide much-needed relief and support to the startup ecosystem during a time of economic uncertainty.
For the ecosystem at large, the ESOPs policy is a critical focus area in the budget.
Why are ESOPs important for startups?
Employee Stock Ownership Plans (ESOPs) are a widely used form of employee compensation where a company grants its employees stock options or shares. These plans are particularly popular among smaller startups, as they provide a valuable tool for attracting and retaining talented employees, and help them grow and scale their businesses. However, despite the benefits of ESOPs, the taxation laws and regulations in India have created confusion and are often viewed as a hindrance to their widespread adoption among companies in the country.
In India, the tax treatment of Employee Stock Ownership Plans (ESOPs) is dependent on the timing of the grant and exercise of the stock options. If an employee receives stock options and chooses to exercise them within a year of the grant date, the difference between the exercise price and the fair market value of the stock on the exercise date is considered as taxable income for the employee. On the other hand, if the employee exercises the options after a year from the grant date, the difference between the exercise price and the fair market value is taxed as a long-term capital gain (LTCG). This system of taxation can create confusion and add complexity for employees and companies.
The current tax treatment of Employee Stock Ownership Plans (ESOPs) in India can put employees at a disadvantage by creating a tax liability even before they have realized any gains from the stock options. This is because the tax liability is computed on the fair market value of the stock on the exercise date, which may not always be an accurate reflection of its true value. This can discourage employees from exercising their options and can negatively impact their ability to benefit from their stock ownership.
Moreover, as startups navigate the new normal and a funding winter, the ESOP policy is a centrepiece of keeping talented employees on board for the long term. The rules and regulations governing ESOPs in India should be reviewed and revised to ensure that they don't discourage employees from participating in these plans and to promote a more equitable and sustainable system for everyone.
In previous budgets, the government has taken some steps to address the issues surrounding the tax treatment of Employee Stock Ownership Plans (ESOPs) in India. For example, in 2020, taxes on the exercise of ESOPs were removed for certain startups. However, this relief was only applicable to startups incorporated after April 1, 2016, and registered with the Department for Promotion of Industry and Internal Trade (DPIIT) that have an annual revenue of less than Rs 100 crore.
This leaves out a large number of companies and employees who could benefit from this change. The government should consider expanding the scope of this relief to include more companies and employees, or review and revise the current regulations to ensure a more equitable and sustainable system for everyone.
This move penalised successful startups for generating money and was counterproductive. A slew of additional restrictions, such as approval by an inter-ministerial board and IT department ensured that only a fraction of the startups got these benefits.
ESOPs also face double taxation, first at the Fair Market Value (FMV), and then at the time of buyback or secondary sale.
To promote the widespread adoption of Employee Stock Ownership Plans (ESOPs) in India, it is important for the government to consider implementing changes to the current tax treatment of these plans. One potential solution would be to tax stock options only when they are sold, rather than on the exercise date.
This would eliminate the issue of double taxation and align the taxes of ESOPs with stock options and restricted stock units, which are already taxed when sold. This change would simplify the process for employees and companies and make ESOPs a more attractive compensation option. We hope the Finance Minister will consider these suggestions in the upcoming budget and take steps to create a more equitable and sustainable system for all.
In addition to considering changes to the tax treatment of Employee Stock Ownership Plans (ESOPs), it would also be beneficial for the government to offer a tax holiday for employees who exercise their stock options. This would mean that employees would not have to pay any tax on the stock options for a certain period, such as five years. This would provide employees with a strong incentive to exercise their options and align their interests with those of the startups and MSMEs they work for. This would also help startups to retain and attract talented employees, which would be beneficial for the company's growth and success. We hope the Finance Minister will consider these suggestions in the upcoming budget and take steps to create a more equitable and sustainable system for all.
As the economy faces the possibility of a recession and capital becomes scarce, it is more important than ever for the government to take steps to support startups and small businesses. One way to do this would be to make positive changes to the tax treatment of Employee Stock Ownership Plans (ESOPs). This would allow startups to retain and attract talented employees, which is critical for their growth and success. By aligning the interests of employees with those of the company, startups will be better positioned to participate in the government's "Make in India" initiatives and play a more active role in driving the Indian economy forward. This would be especially important during a time of economic downturn, a positive move on ESOPs will ensure that startups can continue to grow and contribute to the country's development.
—The author, Ravi Kumar, is Founder & CEO, udChalo. The views expressed are personal
(Edited by : C H Unnikrishnan)
First Published: Jan 31, 2023 9:30 AM IST
