Tax Implications of Foreign ESOPs for Indian Employees

When a foreign parent company gives stock options to employees working in its Indian subsidiary, things can get tricky. Between income tax, capital gains, FEMA rules, and now even GST, there’s a lot to unpack for both the company and the employee.

In this blog, we break down everything you need to know about how foreign ESOPs are taxed in India.

Who is eligible for foreign ESOPs in India?

In India, only employees of the Indian subsidiary, branch, or office of a foreign company are eligible to receive ESOPs granted by the foreign parent.

To qualify, the following conditions must typically be met:

a. The individual must be a full-time employee or director of the Indian entity

b. The foreign company must hold equity, either directly or indirectly, in the Indian entity.

FEMA and Overseas Portfolio Investment (OPI) rules for foreign ESOPs

When Indian employees receive ESOPs from a foreign parent company, the transaction falls under the purview of FEMA (Foreign Exchange Management Act). 

As of August 2022, these equity awards are treated as Overseas Portfolio Investments (OPI) under the revised Overseas Investment Rules and Regulations, 2022, issued by the Ministry of Finance and regulated by the Reserve Bank of India (RBI). This replaces earlier treatment under the Liberalised Remittance Scheme (LRS).

Here’s what that means:

1. Uniformity requirement

The foreign parent must offer ESOPs to Indian employees on the same terms as those offered to employees in other jurisdictions.

2. Reporting obligations

a. If the ESOP cost is charged back to the Indian subsidiary, the Indian entity is required to file Form OPI on a semi-annual basis through its Authorized Dealer (AD) bank.

b. These filings are due within 60 days from the end of March and September each year.

‍3. Repatriation rules

If an employee sells shares or receives dividends from a foreign company:

a. And their holding is less than 10% of the foreign company’s share capital, the funds must be repatriated to India or reinvested within 180 days.

b. If their holding is 10% or more of the foreign company’s share capital, this period reduces to 90 days.

Note: Repatriation refers to the process of bringing money earned abroad (like through a share sale) back to your home country.

RBI compliance by Indian subsidiaries for foreign ESOPs

Under the Foreign Exchange Management Act (FEMA), the Indian subsidiary must file Annual Return (Annexure B) to the Reserve Bank of India (RBI) via the Authorized Dealer (AD) bank in case:

a. ESOPs are issued by the foreign holding company to Indian employees.

b. Shares are repurchased by the foreign company after being issued under the ESOP scheme.

c. The Indian subsidiary must maintain appropriate entries in the Register of Directors and Key Managerial Personnel (KMPs) if ESOPs are issued to them.

Taxation of foreign ESOPs for Indian employees

The taxation of foreign ESOPs for Indian employees follows a similar structure to that of Indian ESOPs, as outlined in the Income Tax Act, 1961. 

The process occurs in two stages. 

At the time of exercise

• When an employee exercises vested options and receives shares, the difference between the exercise price and fair market value (FMV) on the date of exercise is considered perquisite income.
• This perquisite is taxed as salary income at the employee’s applicable income tax slab rate.
• This tax is due at exercise even if shares are not sold immediately

The Indian employer is responsible for deducting TDS on the perquisite value at the time of exercise and reporting the same in the employee's Form 16.

At the time of sale

• When the employee eventually sells the shares, capital gains tax is levied based on the duration of holding and type of shares:

1. Short-Term Capital Gains (STCG) if held for less than 24 months from exercise (this period is reduced to 12 months in case of public companies).
2. Long-Term Capital Gains (LTCG) if held for more than 24 months from exercise (this period is reduced to 12 months in case of public companies).

Capital gains = Sale price – FMV on date of exercise.

What about double taxation for Indian employees?

When Indian employees receive equity compensation from a foreign employer, there's often a concern about double taxation. This means paying tax both in the country of the employer (e.g., the U.S.) and in India, where the employee is a tax resident.

However, India has Double Tax Avoidance Agreements (DTAAs) with several countries, including the U.S., which help ensure that individuals don’t pay tax twice on the same income.

At the time of ESOP exercise, the difference between the fair market value of the shares and the exercise price is treated as a perquisite (part of your salary) in India. This amount is added to your taxable income and taxed at your applicable slab rate. Your employer is also required to deduct TDS on this income.

In some cases, the foreign employer may withhold taxes in its own country, often through a sell-to-cover transaction, where a portion of your shares is sold to cover the estimated tax liability abroad.

If any foreign tax is withheld, you can claim a foreign tax credit when filing your Indian income tax return. This credit applies both to perquisite income and capital gains.

Accounting standards and cost cross-charging of ESOP costs for foreign ESOP taxation in India

1. ESOP accounting standards

When a foreign company grants ESOPs to employees of its Indian subsidiary, both the foreign parent and the Indian subsidiary have accounting responsibilities.

The foreign company must comply with IFRS 2, recognizing the fair value of the ESOPs as an expense over the vesting period.

The Indian subsidiary, following Ind-AS 102, must also record the expense but only if the cost of the ESOPs is cross-charged to it by the foreign parent.

2. Cost cross-charging

The parent company typically recovers the ESOP-related expense by invoicing the subsidiary, a process known as cross-charging.

The Indian subsidiary must recognize this cost in its profit and loss account, treating it as an employee benefit expense. This allocation affects the company’s taxable income, transfer pricing documentation, and profitability.

GST considerations on cross-charging foreign ESOP expenses to Indian subsidiaries

​The taxation of cross-border Employee Stock Option Plans (ESOPs) has been a subject of considerable discussion in India. 

Historically, the Goods and Services Tax (GST) authorities contended that when a foreign parent company grants ESOPs to employees of its Indian subsidiary and subsequently cross-charges the associated costs, it constitutes an "import of service." This interpretation led to the assertion that such transactions should attract an 18% GST under the reverse charge mechanism.​

However, a significant development occurred on June 26, 2024, when the Central Board of Indirect Taxes and Customs (CBIC) issued Circular No. 213/07/2024-GST, providing much-needed clarity on this matter. 

The circular elucidated that if the Indian subsidiary reimburses the foreign parent company strictly on a cost-to-cost basis for the ESOPs granted to its employees, such transactions do not constitute a supply of services and, therefore, are not subject to GST.

FAQs

1. How are foreign ESOPs taxed in India?

The way foreign ESOPs are taxed for Indian employees largely mirrors the tax treatment of domestic ESOPs under the Income Tax Act, 1961.

At the time of exercise: The difference between the fair market value (FMV) of the shares on the exercise date and the exercise price is treated as a perquisite (salary income). It is taxed at the employee’s applicable income tax slab, and the employer must deduct TDS.

At the time of sale: When the employee sells the shares, the capital gains are taxed. The gain is calculated as the difference between the sale price and the FMV on the date of exercise. 

2. Is ESOP taxed twice in India?

ESOPs generally trigger two taxable events in India.

a. First, it's taxed as salary (perquisite) when you exercise the options and receive shares.

b. Then, it's taxed again as capital gains when you sell those shares later.

However, if the employee sells their shares immediately after exercising, the capital gain is typically negligible or nonexistent, as the sale price is likely to be very close to, or equal to, the FMV at exercise.

If you're wondering whether foreign ESOPs are taxed twice, the answer is no. 

If any foreign tax is paid at either of the above stages, you may be eligible to claim a foreign tax credit under the Double Taxation Avoidance Agreement (DTAA) to prevent double taxation on the same income.

3. When does the taxable event occur for foreign ESOPs in India?  

In India, the taxable event for foreign ESOPs typically occurs at two stages:

When the employee exercises the stock option, the difference between the exercise price and the fair market value (FMV) of the shares at the time of exercise is treated as a perquisite and is taxed as salary income.

When the employee sells the shares, any capital gain (i.e., the difference between the sale price and the FMV at the time of exercise) is taxed as capital gains, either short-term or long-term, depending on the holding period.

4. How are capital gains from foreign ESOP shares handled after the exercise in India? 

After an employee exercises their options and later sells the shares, any profit from the sale is treated as a capital gain. The gain is calculated as the difference between the sale price and the market value at the time of exercise. The tax rate depends on the holding period, with different rates for short-term and long-term gains.