Changes in capital gains tax structure will impact ESOPs

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The news of the government mulling over the change in short term capital gains tax in the Union Budget may have a significant impact on the Employee Stock Options (ESOP) offered by companies to their employees. At the end of the day, it will impact the timing of when the employees decide to sell the shares acquired through exercise of ESOPs and it may not be all that bad from the company and shareholders’ perspective.

Change in Short Term Capital Gain (STCG) Tax from 15 percent to 20 percent

STCG is levied on the difference between the sale price and share price on the date of exercise for shares acquired through exercise of stock options. If there is an increase in STCG, any shares acquired by employees upon exercise of ESOPs and sold within one year (for listed companies) from the date of acquisition will attract higher tax. This may push employees to hold the shares for a longer period to get to Long Term Capital Gains (LTCG) applicability which the finance minister has said may not be changed from zero percent currently. Increase in STCG may actually be beneficial for the company as the employees will tend to hold the shares rather than pay higher tax and hence remain invested in the company for a longer period and the performance of the company continues to impact employees’ wealth.

Increase in time frame to avail LTCG benefit from 12 months to 36 months

If the government decides to increase the time frame to avail LTCG benefit from 12 months to 36 months, this may again push employees to hold the shares acquired through exercise of ESOPs for a longer period. This could specifically be the trend in the companies that have shown a consistent increase in share price over the years. From the shareholders’ perspective, this will be quite beneficial as they will have the management tied in with their interests for a longer time.