ESOPs can be taxed as a perquisite or capital gains

I have exercised employee share option plan of 200 shares of my company. The grant price was Rs 630 a share. Fair market value (FMV) date was June 21, 2011, at Rs 2,314. Exercise price per share was Rs 1,151.

Suppose, if I sell 100 shares at Rs 2,500 a share, what will be my tax liability? I will have to pay short-term capital gains at 15 per cent, right? But on what amount? Is it on Rs 1,34,897 (Rs 2,50,000 less Rs 1,15,103) or on Rs 18,517 (2,50,000-2,31,483)? Apart from short-term capital gains, do I have to include the amount in my income for shares getting shares less than the market price? Then how much should I include? As my employer has already deducted and paid perquisite tax, do I have to show it again in my returns? — K.S. Nagesh

Under the Income-Tax Act, there are two stages of taxation in share allotment under the employee equity incentive plans. When the shares are allotted by the employer to employee, it is taxed as perquisite. When the shares are sold by the employee, it is taxed as capital gains.

In your case, the employer should have computed the difference between the FMV of the shares on the date of exercise and the exercise price paid by you and taxed the same as perquisite on the date of allotment of shares. The income and the taxes paid will reflect in the Form 16 and you should report it as part of salary in your personal tax return.

When you sell the shares, you would compute the capital gains as difference between the sale proceeds and FMV of the shares considered by the employer while computing the perquisite value including any expenditure incurred wholly in connection with the sale.

Taxation of capital gains from sale of equity shares depends on the period of holding from date of allotment to date of sale. If the said shares are sold after holding for more than 12 months from the date of allotment, the capital gains are termed as long-term capital gain (LTCG).

If Securities Transaction Tax is paid on such LTCGs, you can get full exemption. In case STT is not paid, LTCG would be taxable at 20 per cent (with benefit of indexation) or 10 per cent (without benefit of indexation).

Where the holding is not more than 12 months, the capital gains are short-term capital gains (STCG) and where STT is paid at the time of sale, tax will be applicable at 15 per cent. If STT is not paid, applicable maximum marginal tax rate would apply. Additional education cess would apply on these rates.

Assuming FMV of Rs 2,314 has been considered by the employer for perquisite taxation, capital gains should be Rs 18,600 (i.e. Rs 250,000 less 231,400).

I had purchased a flat of 700 sq.ft in 1970 for Rs 30,000. During redevelopment process the builder has offered 50 per cent extra which would make the new flat 1,050 sq.ft. But I opted for 860 sq.ft and surrendered 190 sq.ft (1050-860) for a consideration of Rs 13,30,000 which the builder has agreed to pay in 6 instalments during the next three financial years till the possession of the new flat.

What is the tax implication that would arise from the transaction? Would index cost be applicable? If capital gain arises, would it be for one year? — Padwal

To comment on taxability of this transaction it would be crucial to examine the terms of the development agreement specifically on the right to re-possess the house by the owner in the event of failure or delay on the part of the developer in satisfying various obligations contained in the development agreement. As there are no direct provisions in the Act for taxation of such transactions, we can share general views based on what has been held in various case laws.

Assuming that you have executed a General Power of Attorney in favour of the developer in the financial year (FY) 2011-12 and also you have handed over the possession of the initial residential flat to the developer for its re-development in the FY, this transaction would be treated as transfer of capital asset in 2011-12. Generally, where there is irrevocable transaction, the transfer is said to have concluded in year one itself and the fact that the sales consideration will be received in six instalments in three years should not impact.

The gains arising from such sale would be taxable as capital gains in your hands. As the property has been held for more than 36 months, the capital gains will be termed as long-term capital gains (LTCG). The gains may be computed as difference between the net sales proceeds and the ‘indexed cost of acquisition'.

The sales consideration may be taken as Rs 1,330,000 plus the equivalent cost of construction of 860 sq.ft. of the re-developed flat as borne by the developer.

Please note that there is a debate on if the cost of construction or the market value of the new house should be considered as sales consideration.

Cost of acquisition will be the cost you have incurred to purchase the initial flat which would be indexed appropriately. Such LTCGs are taxed at 20.60 per cent (including education cess).

Under section 54 of the Act, an exemption is available on LTCGs where the individual purchases the new house within one year prior to or two years after transfer of the original house or within three years of transfer constructs a new house. The exemption is equivalent to the cost of the new house or capital gain, whichever is lower.

Accordingly, the fact that you will receive new residential flat through the re-development agreement could be taken as utilisation of LTCGs on sale of residential property in construction of new house for claiming deduction under section 54 of the Act.

The construction must be completed within three years of transfer of your house. If the capital gains are more than the cost of new flat of 860 sq.ft, the deduction can be claimed to the extent of cost of new flat.