ESOP – Taxation in India
Introduction
Retaining and keeping the employees highly motivated is of utmost importance to any organization. There are various strategies adopted by Companies to do so. One of the many strategies is issuing stock options. SEBI has formulated the Securities and ExchangeBoard of India (Employee StockOption Scheme and Employee Stock PurchaseScheme) for governing ESOP’s in India.
Taxation of ESOP’s in India was brought in the Finance Act, 1999. ESOP is taxed in two stages:a. First as a perquisite – When the option is exercised after the vesting period is over, the perquisite value will be added to income and taxed at the slab rate. Employer would deduct taxes at source. This perquisite value is the difference between fair market value of the share and the exercise price.
b. Second as Capital gain – When the allotted shares are sold by the employee, the capital gain will be the sale price minus the fair market value considered earlier. It will be taxed depending on the period for which it has been held.
Same is explained below with an example:
Cross border stock option plans:
In cross border stock option plans, the employees of Indian companies are allowed to participate in the global stock option plans of the group companies. There are multiple laws and regulations to be adhered to, such as, exchange control, labor laws, taxation, etc.
As discussed above, taxation of ESOP occurs in two stages. In the first stage, the employee pays taxes at the time of exercising the option. The employer would be required to deduct taxes at source. However, in the global stock options, there is no employer-employee relationship with the India employee and the foreign company.
To give rise to “perquisite” an employer-employee relationship is necessarybetween the company issuing the options and the options. In cross border stockoption plans, as the Indian company does not issue options, no “perquisite” canbe said to arise. However, the Authority for Advance Rulings in case Microsoft Corp US [1999] 102 Taxman 74 (AAR), it was held the foreignholding company and the Indian subsidiary should be treated as the sameentities and the stock options granted by a foreign company to the employees of wholly owned company should be taxed in India and the foreign company would have to deduct taxes.
Taxation of dividends received on ESOP – Dividends repatriated into India are subject to tax as ordinaryincome. They are not added to the salary of the employee and the local employeris not required to withhold taxes. If under the laws of the country (where thecompany issuing the options is a resident) taxes have been withheld at source,then depending upon the relevant treaty provisions the Indian resident employeemay be able to obtain tax credits.