Employees Face Tax Burden on Illiquid ESOP Shares, Radhika Gupta Advocates for Reforms

Radhika Gupta Calls for Overhaul of India's ESOP Taxation Framework

Edelweiss Mutual Fund managing director and chief executive officer Radhika Gupta has urged the government to review the way employee stock ownership plans (ESOPs) are taxed in India. In a series of posts on the X platform, Gupta advocated for a system where employees are taxed only when they receive cash after selling shares, rather than when they exercise their stock options or sell their shares.

Gupta's comments were in response to investor Vijay Kedia's suggestions to the government. She specifically urged Finance Minister Nirmala Sitharaman to review the taxation of ESOPs, particularly for employees of unlisted companies. Gupta noted that ESOPs are currently taxed at two stages: when employees exercise their stock options, and when they sell their shares. The first tax arises when employees exercise their stock options, with the difference between the exercise price and the fair market value of the shares treated as salary income and taxed as a perquisite. The second tax is levied when the shares are sold, with any additional gains taxed as capital gains.

However, Gupta argued that the bigger concern is not double taxation, but the timing of taxation and liquidity. She pointed out that employees of unlisted companies are often required to pay taxes on a notional value determined through valuation exercises, even though they may have no way to sell their shares and realize any cash gains. In many cases, there is no certainty about when an exit opportunity will arise or whether the valuation will ultimately be justified.

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Gupta noted that the current framework creates an imbalance, where founders and investors are rewarded for taking long-term risks, while employees can face tax liabilities on unrealized gains. She argued that ESOPs have evolved beyond being merely a compensation tool and are increasingly becoming a means for employees to participate in wealth creation. If India wants to strengthen its startup ecosystem, encourage talent retention, and promote wider ownership, the tax system should align with those goals.

Gupta's Proposed Solution

A more practical approach, according to Gupta, would be to tax ESOP holders when liquidity is created, rather than when options are exercised. This would ensure that employees are taxed only when they have the ability to sell their shares and realize any cash gains. By aligning the tax system with the goals of promoting entrepreneurship, talent retention, and wider ownership, India can create a more conducive environment for startups and entrepreneurs to thrive.

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