Stock options have become a popular tool for compensating employees, especially in startups, technology firms, and multinational corporations. These options give employees the right to purchase shares of the company at a fixed price, often lower than market value, after a certain vesting period. In Pakistan, the taxation of stock options is governed primarily by the Income Tax Ordinance, 2001, and involves complex considerations such as the timing of taxability, valuation of shares, and classification of income. This article provides a comprehensive guide to the taxation of stock options in Pakistan for employees, employers, and companies issuing equity compensation.
What Are Stock Options?
Stock options are contracts that give employees the right to buy company shares at a predetermined price (called the strike price) after a specific period (called the vesting period). The two main types of stock options are:
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Employee Stock Option Plans (ESOPs)
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Restricted Stock Units (RSUs)
ESOPs are more common in Pakistan and are structured to attract and retain employees through equity incentives.
Legal and Regulatory Framework in Pakistan
Stock options are regulated under:
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Income Tax Ordinance, 2001
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Companies Act, 2017
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Income Tax Rules, 2002
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SECP notifications and Circulars
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IFRS 2 (Share-based Payments) for financial reporting
The taxation event, valuation, and tax rate depend on the nature and timing of option exercise and shareholding.
Stages of Stock Option Lifecycle and Tax Treatment
1. Grant Date:
The date when the stock option is awarded to the employee.
Taxability: No tax at this stage, as the option has not been exercised or vested.
2. Vesting Date:
The date when the employee becomes eligible to exercise the option.
Taxability: No tax triggered until actual exercise of the option.
3. Exercise Date:
The date when the employee purchases the shares by paying the strike price.
Taxability: Taxable event. The difference between market value and strike price is taxed as salary income under Section 12(2)(e) of the Income Tax Ordinance, 2001.
4. Sale of Shares:
When the employee sells the shares, resulting in capital gain or loss.
Taxability: Capital Gains Tax (CGT) under Section 37 applies on the difference between sale price and market value on exercise date.
Tax Treatment at Exercise
Under Section 12(2)(e), the fair market value (FMV) of shares minus the strike price is considered a benefit in kind, taxable under the salary head.
Example:
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Strike Price: Rs. 50
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FMV on exercise: Rs. 150
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No. of Shares: 1,000
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Taxable Benefit = (150 – 50) × 1,000 = Rs. 100,000
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Added to salary income for the year and taxed as per applicable salary tax slabs
Employer’s Responsibilities at Exercise:
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Deduct withholding tax under Section 149
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Report benefit in salary and issue tax certificate
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Reflect in monthly and annual withholding statements
Tax Treatment on Sale of Shares
Once shares are sold, Capital Gains Tax (CGT) is applicable under Section 37, provided the employee is the legal owner.
CGT Calculation:
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Sale Price – FMV at Exercise = Capital Gain
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CGT for ATL filers = 15%
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CGT for non-filers = 30%
Holding Period Consideration:
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Holding shares less than 1 year = taxable CGT
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More than 1 year (for listed shares): CGT may be exempt (subject to Finance Act and FBR rules)
Unlisted Companies:
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FMV must be determined through a valuation report or recent funding round
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No exemption based on holding period; CGT applies regardless
Taxation of RSUs (Restricted Stock Units)
If RSUs are granted instead of options:
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RSUs are taxed at vesting, not exercise
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FMV on vesting date is taxed as salary income
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CGT applies on sale of shares as per gain/loss
Foreign Stock Options and Pakistan Tax Residents
If a Pakistani tax resident receives stock options from a foreign parent company:
At Exercise:
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Taxable as salary income, even if company is not Pakistani
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Benefit must be reported by employee in annual tax return
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No automatic employer withholding unless payroll is in Pakistan
At Sale:
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Capital gain/loss must be calculated
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CGT payable to FBR based on global income taxation rules
Exchange Rate Consideration:
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Income is converted using SBP’s official rate on exercise/sale date
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Documentation (option agreement, payslip, trading statement) required
Employer Tax Implications
1. Deduction of Expense:
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Employers can deduct the ESOP-related expense as a business deduction if:
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Properly accounted under IFRS 2
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Reflected in payroll and financial statements
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Taxed under Section 12 as part of salary
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2. Reporting Obligations:
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Reflect share-based compensation in Form 47 (salary certificate)
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Include in monthly withholding statement
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Maintain detailed ESOP agreement and exercise log
3. FBR and SECP Compliance:
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File disclosure of ESOP plans with SECP
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Retain documentation for tax audits
Common Challenges in ESOP Taxation in Pakistan
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Lack of clear valuation for unlisted shares
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Employees not informed about tax liabilities
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Confusion over foreign vs domestic ESOPs
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Late filing of returns with unreported stock income
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Misclassification of gains as capital vs salary
ESOP Planning Tips for Employers
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Draft a clear and compliant ESOP policy
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Determine vesting schedules and valuation methods
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Withhold tax at exercise where possible
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Provide tax training or guidelines to employees
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Align ESOPs with performance and retention goals
Tax Planning for Employees
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Consider deferring exercise until lower income year
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Track cost base for CGT calculation
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File timely income tax returns
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Declare foreign ESOP benefits under Section 101 (Pakistan-source income) if required
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Keep documentation: option grants, vesting schedules, tax slips
Audit and Record Requirements
Both employees and companies must maintain:
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Option agreements and grant letters
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Exercise and vesting dates
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Strike price and FMV details
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Tax challans and WHT certificates
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Sale documents and trading statements
FBR can demand this documentation during audit proceedings or scrutiny notices.
FAQs on Stock Option Taxation
Q. Are stock options taxable at grant?
A. No. Tax is triggered at exercise (ESOPs) or vesting (RSUs).
Q. Who pays the tax on stock option income?
A. The employee is liable, but employers must withhold tax under Section 149 where applicable.
Q. How is CGT calculated for ESOPs?
A. CGT = Sale Price – FMV at Exercise. Tax rate = 15% (filers), 30% (non-filers).
Q. Are stock options from foreign companies taxable in Pakistan?
A. Yes, if the employee is a Pakistan tax resident, global income is taxable.
Q. Are there exemptions available on stock options?
A. No specific exemption exists. However, long-term CGT exemptions may apply to listed securities.
Q. What happens if I don’t report ESOP income?
A. FBR can issue tax notices, impose penalties, and require evidence of compliance.
Conclusion
Stock options are a powerful form of employee compensation but come with important tax implications in Pakistan. Employees must pay salary tax at exercise or vesting and capital gains tax on sale, while employers are obligated to withhold tax and maintain compliance. The lack of awareness and documentation often leads to underreporting and legal complications. Proper planning, valuation, and compliance with Sections 12, 37, and 149 of the Income Tax Ordinance, along with SECP guidance, are essential for companies and employees to optimize stock option benefits and remain on the right side of tax law.
