How are gains from ESOPs listed abroad taxed? All you want to know

Companies off late do spend a lot of their time and money in recruiting and training their human resources and hence are interested in retaining their employees for longer. The Employee Stock Option Plan (ESOP) comes in as a very effective tool in assisting companies to meet this objective.

What is an ESOP and how does it work?

The ESOP is a scheme under which the employees, as part of their salary package are allowed to become stockholders of the company they work in by allowing them the right to purchase shares of the company. Such right is given in the form of stock options which are provided at a very concessional price in comparison with the probable market price of these shares. A company by resorting to this scheme is dually benefitted, one in terms of being able to retain its employees by committing to make them stockholders and the other by not disturbing the company’s cash flow.

An organisation grants ESOPs to its employees for buying a specified number of shares of the company at a defined price after the option period (a certain number of years). Before an employee could exercise his option, he needs to go through the pre-defined vesting period which implies that the employee has to work for the organization until a part or the entire stock options could be exercised.

ESOPs of foreign companies and taxability of ESOP gains in India

With India becoming a tech hub, a lot of foreign companies have set up their subsidiaries in India. These subsidiaries recruit people who, as part of their package, are sometimes offered ESOPs of the foreign company.

ESOPs of Indian companies, when exercised, are taxed as perquisites in the hands of the employees and as capital gains when sold by them. Coming to taxability of ESOPs of foreign companies, first and foremost, one needs to determine the residential status of the taxpayer employee. If the employee is a non-resident, the question of taxability of such ESOPs in India would not arise at all.

If the employee is a resident of India, tax implications in India need to be looked into. Firstly, if the ESOP has been allotted by the foreign holding company, there are views that such holding company would be deemed to be the taxpayer’s employer and therefore such ESOPs will be taxed as perquisites in the hands of the taxpayer employee. However, there is no finality on this viewpoint yet. Taxpayers are recommended to seek expert help to solve this. Secondly, any income by way of dividend received from such stocks would be taxable in India under “Income from Other Sources”.

Moving on to taxability of these ESOPs when they are sold by the employee, gains from such sale will be taxed as capital gains in India. The gains would be short term or long term depending on the period of holding of these shares. While the period of holding of Indian listed shares to be considered as long-term, is more than twelve months, that of foreign-listed shares is more than twenty-four months, to be considered as long-term.

Do note that long-term gains on sale of Indian listed equity shares are taxable at a concessional rate of 10 per cent while there is no such concessional rate of tax applicable for ESOPs of foreign listed companies.

While there is a possibility that dividend or capital gains from such foreign stocks could also be taxed in the country of residence of the foreign company, the Double Taxation Avoidance Agreement that India has entered into with various countries would come to a taxpayer’s rescue and help eliminate double taxation by allowing him to claim a Foreign Tax Relief.

Reporting of Foreign ESOPs in the income tax return

A resident taxpayer holding such ESOPs must report any income (dividend, gains etc) in his return of income filed in India under Schedule FSI. Further, he is also said to have financial interest in such foreign company details of which he must disclose in Schedule FA in his return. Also, if he intends claiming any Foreign Tax Relief, he must report details of taxes paid in the foreign country in Schedule TR.

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(Archit Gupta is Founder & CEO ClearTax. Views are his own.)