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Budget 2020: Tax Relaxation under Employee Stock Ownership Plan a Boost for Start-ups

Finance Minister Nirmala Sitharaman.

Finance Minister Nirmala Sitharaman.

Several companies use the ESOP mechanism to motivate and strengthen their relationship with their employees by sharing the growth-benefits to make them stick to the enterprise and help them create wealth in the long run.

To foster growth and employment in start-ups amid the economic slowdown, Finance Minister Nirmala Sitharaman proposed relaxation of payment of tax on allotment of shares under employee stock ownership plan (ESOP) in Budget 2020.

Entrepreneurs gather an idea and build a risk-taking team and have to create viable businesses out of thin air.

Several companies use the ESOP mechanism to motivate and strengthen their relationship with their risk-taking employees by sharing the growth-benefits to make them stick to the enterprise and help them in creating wealth in the long run.

The existing tax regime did not favour issue of shares under ESOP scheme by taxing them at the time of issue of shares.

The Union Budget proposed the deferment of payment of tax on shares issued to employees under ESOP scheme — up to (i) five year from the end of the financial year in which the shares are issued, (ii) the date of employee ceases to be employed with the company, and (iii) the date of the sale of shares by the employee.

The delay in issue of shares, in most of the cases, resulted in lower motivation for the employee, dis-trust between employer and employees and reduction in growth potential of the company. Deferment of payment of tax on issue of shares to the employee shall mitigate these issues to a large extent.

The budget proposal has only deferred the tax payment/tax withholding, but it is not clear if the taxability event has also been deferred. Clarification in this regard is awaited.

In addition to relaxation in payment of tax on allotment of shares, the Budget has also provided that start-ups will be able to claim tax deduction of 100% of profits of their businesses under Section 80-IAC for three consecutive years out of the first 10 years.

Earlier, these start-ups were eligible for three years exemption, out of first seven years only. Also, start-ups of up to Rs 100 crore turnover per year are eligible now. The limit was Rs 25 crore earlier.

Start-ups are not eligible for deduction under Section 80-IAC unless they hold a certificate from the Inter-Ministerial Board of Certification in addition to the start-up registration.

The Union Budget also proposed a Knowledge Translation Cluster to encourage start-ups in knowledge-driven industry, a digital platform for capturing intellectual properties, and a seed fund to support ideation and development of early-stage start-ups.

(The author is a chartered accountant. Views expressed are personal.)