Highlights
- Reduction in Long-Term Capital Gains (LTCG) tax on unlisted securities to 12.5% from 20% could benefit startup staffers holding Employee Stock Ownership Plans (Esop).
- Secondary funding rounds where an investor buys shares providing liquidity to employees are often termed as Esop buybacks.
- Several late-stage companies are using secondary funding rounds to provide liquidity to employees holding stock options.
The reduction in long-term capital gains (LTCG) tax on unlisted securities to 12.5% from 20% could benefit startup staffers holding employee stock option plans (Esop), if their shares are bought by an investor during a secondary funding round, founders and tax experts said.
While such deals are often conveniently termed as Esop buybacks — even though the shares are not repurchased by the company that issued them — these are typically secondary deals where an investor is buying the shares providing liquidity to employees.
“It is called buybacks for ease of understanding … but in most cases, it is an investor coming in and purchasing these shares. The reduction in LTCG for unlisted stocks will hugely benefit the employees participating in these exercises,” a cofounder of a unicorn fintech startup said.
If the buyback is by the issuer, the pay-out is treated as bonus and the employees may face higher tax depending on their total taxable income.
Over the recent months, several late-stage companies that are stitching together secondary funding rounds are using such events to provide liquidity to employees holding stock options.
Earlier this month, food and grocery delivery platform Swiggy, which has filed for a $1.25 billion initial public offering, announced its fifth Esop liquidity programme. As part of the scheme, Swiggy has offered to buy back shares by employees for up to $65 million.
In May, home service marketplace Urban Company announced its largest secondary sale of employee stock, worth Rs 203 crore (around $24 million). This was a part of the secondary transaction closed by the Gurugram-based firm, through which Dharana Capital (an offshoot of existing investor Vy Capital), along with other existing investors Vy Capital and Prosus Ventures purchased these shares.
In March, ecommerce firm Meesho announced an Esop buyback programme worth Rs 200 crore, through which investors bought the stock options from its employees.
Other companies to have conducted these exercises in the past few months include Google-backed test prep company Adda247, Tiger Global-funded MyGate and Premji Invest-backed direct-to-consumer brand The Sleep Company.
Tax experts, however, pointed out that the final benefit of the change in tax regime will be understood only on a case-to-case basis, given that indexation has been removed on LTCG tax.
“It is important to note that the benefit of indexation of cost of acquisition shall no longer be available, and hence, it shall have to be seen on a case-to-case basis as to whether the reduction in tax rate is leading to a reduction in tax liability or not,” SR Patnaik, partner (head – taxation) at law firm Cyril Amarchand Mangaldas told ET.
“From our experience, it is evident that most of the shares are sold within a short period of time after they are subscribed to and thus, the benefit of lower tax can accrue to the employees because the benefit of indexation may not be significant,” he added.
In July last year, ecommerce marketplace Flipkart conducted the biggest such exercise, allowing current and former employees to liquidate $700 million worth of Esops, which were purchased by the Bengaluru-based firm’s parent company Walmart.
Patnaik, however, pointed out that in case of pure buybacks — where the company purchases shares from its staff — the employees may have to face additional tax burden.
“The pay-out on buyback to the employee shareholders by the startups shall be taxed as dividends at the rate of 30% plus surcharge and cess. The cost of such shares shall be considered as capital loss and shall be set off in future when the employee sells the balance shares or has any other capital gains transaction,” he said.
“At a conceptual level, buyback of shares (if done by the issuer company itself) will be tax inefficient. However, in case other shareholders or promoters or investors acquire these shares, that would be better because the effective tax cost shall be lower,” Patnaik said.
