This article has been published by Insights Success at Current Trend in Taxation of Stock Options – Insights Success

In today’s fast-paced corporate world, a high attrition rate is a common phenomenon, and to retain key talent, Employee Stock Option Plan (“ESOP”) has emerged as a potent tool. ESOP enables incentivization of employees by offering them shares of the company, either free of cost or at a concessional rate, in return for inter alia their continued performance over a period of time^[1].  The taxability of such incentive is fairly settled in as much as the difference between the value of the shares on the date when a particular employee exercises his/ her option and the price which is actually paid by the said employee, becomes taxable as ‘perquisite’ under section 17(2)(vi) of the Income-tax Act, 1961 (“IT Act”) in the hands of such employee.

In such a case, the employer is obligated to deduct tax at source under section 192 of the IT Act on the said perquisite, which can thereafter, be claimed as a deduction from total income by the employer^[2]. For eligible start-ups^[3], the liability of payment or deduction of tax on such perquisite can be deferred as per the provisions of IT Act^[4]. Where the allotted shares under ESOPs are subsequently transferred by the employee, gains arising therefrom are liable to be taxed under the head “capital gains” in the hands of the employee^[5].

Complications arise where the stock option is granted by a foreign company to the employees of an Indian subsidiary/ group company. In this scenario, the Indian entity reimburses the cost associated with granting ESOPs to its foreign parent/ group company and generally no tax is withheld therefrom under section 195 of the IT Act. The Indian tax authorities have been considering such reimbursement as an expense borne by the Indian entity, which according to the authorities, requires withholding under section 195 of the IT Act^[6]. On the other hand, section 195 of the IT Act, does not mandate withholding of tax on payments made to non-residents, where such payments are not chargeable to tax in India^[7]. Especially in the context of reimbursement on a cost-to-cost basis, there are umpteen number of precedents which clarify that since there is no element of income in “reimbursements”, no tax can be charged thereon under the provisions of the IT Act and consequently, no withholding is required under section 195 of the IT Act.

In this connection, it is pertinent to note that recently, the Central Board of Indirect Taxes and Customs (“CBIC”) vide Circular No. 213/07/2024-GST has taken note of the prevailing trend in issuance of cross-border stock options and clarified that where a foreign holding company directly transfers the shares to the employees of the Indian subsidiary on the request of the said subsidiary, the reimbursement made by the Indian subsidiary to the foreign holding company, on a cost to cost basis, cannot be treated as consideration for any goods or services on which Goods and Services Tax (“GST”) can be levied. Identical clarification for the purposes of IT Act is much required from the Central Board of Direct Taxes (“CBDT”) as well to reduce litigation on this score.

That apart, recently, the High Court of Delhi^[8] opined on the taxability of one-time payment to option holders as compensation towards loss in value of such options. In this case, the employees of the Indian entity, who were granted stock options of the foreign holding company, were granted compensation as a one-time measure, in lieu of loss in the value of such options following a disinvestment made by the foreign holding company and subsequent remittances to its shareholders on account of dividend payments, buy-back etc. The Indian tax authority had taken a view that such one-time payment was chargeable to tax in the hands of employees as perquisite, which therefore, required withholding of taxes by the Indian employer company. On a challenge made by one of the employees, the High Court held that since the said employee had not exercised the option till date and since the payment in question was a one-time voluntary payment by the foreign holding company, the said payment cannot partake the character of perquisite in the hands of such employee and therefore, no tax was required to be withheld therefrom. While in the author’s view, it would have been irrelevant if the option was exercised and stock had already been allotted to the employee in the facts of the case before the High Court, this decision marks yet another example of taxability of compensation made voluntary or through an adjudicatory process. However, it may also be noted that if one-time compensation, such as in this case, is not treated as perquisite in the hands of the employee, the company granting such compensation would be precluded from claiming a corresponding deduction from its taxable income as well.

Another aspect that requires deliberation in the context of cross-border stock options issuance is the applicability of The Black Money (Undisclosed foreign income And Assets) and Imposition of Tax Act, 2015 (“Black Money Act”). Under the Black Money Act, tax is levied, apart from penalty and prosecution, on an assessee in respect of his total undisclosed foreign income and asset. Furthermore, failure to disclose foreign asset (including financial interest in any entity) in the return of income also attracts penal provisions under the Black Money Act.

An interpretation can be taken that stock options granted under an ESOP scheme by foreign entities to the employees of Indian subsidiary may qualify as financial interest in an entity and thus foreign asset, thereby requiring appropriate declarations in the return of income of employees. This interpretation is further strengthened by the recent Budget (2024) Speech by the Finance Minister, extracts whereof are reproduced herein below:

“159. Indian professionals working in multinationals get ESOPs and invest in social security schemes and other movable assets abroad. Non-reporting of such small foreign assets has penal consequences under the Black Money Act. Such non-reporting of movable assets up to ₹ 20 lakh is proposed to be de-penalised.”

While the proposed amendment seeks to de-penalise non-reporting of movable assets up to INR 20,00,000/-, it is the intent shown by the Legislature around the definition of “financial interest in any entity”, which is critical from the perspective of taxation of employees in India.  Therefore, care must be taken by employees in India, who are holding stock options of foreign companies regarding disclosures thereof to be made in the return of income.

Footnotes:

[1]  Section 2(37) of Companies Act, 2013 defines “employees’ stock option” to mean “the option given to the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for the shares of the company at a future date at a pre-determined price”.

[2] As per section 192(1A) of the IT Act, an employer, may at his option, pay tax on the non-monetary perquisite value without making any deduction therefrom. In such a case, the tax so paid over and above the non-monetary value would be treated as exempt from income tax in the hands of the employee as per section 10(10CC) of the IT Act. Furthermore, the employer can claim deduction of the discount on issuance of ESOP from its taxable income. See Biocon Ltd. v. DCIT, (2013) 25 ITR(T) 602 (Bangalore – Trib.) (SB), as upheld in CIT v. Biocon Ltd., (2021) 430 ITR 151 (Karnataka High Court).

[3]  As per Explanation to section 80-IAC of the IT Act, an “eligible start-up” means a company or a limited liability partnership engaged in eligible business which fulfils the following conditions:

• It is incorporated on or after April 01, 2016 but before April 01, 2025;
• The total turnover of its business does not exceed INR 100,00,00,000/- in the year for which deduction under section 80-IAC(1) of the IT Act is claimed; and
• It holds a certificate of eligible business from the Inter-Ministerial Board of Certification as notified in the Official Gazette by the Central Government.

Furthermore, as per Explanation to section 80-IAC of the IT Act an “eligible business” means a business carried out by an eligible start-up engaged in innovation, development or improvement of products or processes or services or a scalable business model with a high potential of employment generation or wealth creation.

[4] Section 192(1C) of the IT Act. Also see section 191(2) of the IT Act.

[5] As per section 2(42A)(hb) of the IT Act, where shares are allotted by the employer to his employee at a concessional rate or free of cost, the period of holding will be considered from the date of allotment of such shares. Further, as per section 49(2AA) of the IT Act, the cost of acquisition of a share allotted pursuant to an ESOP scheme shall be the fair market value of such share as determined in accordance with Rule 3(8) of the Income-tax Rules, 1962.

[6] Failure to deduct tax at source while making payment to a non-resident inter alia invites disallowance under section 40(a)(i) of the IT Act.

[7] Engineering Analysis Centre of Excellence (P.) Ltd v. CIT., (2022) 3 SCC 321 (Supreme Court) and GE India Technology Cen (P.) Ltd. v. CIT, (2010) 10 SCC 29 (Supreme Court).

[8]  Sanjay Baweja v. DCIT., (2024) 163 taxmann.com 116 (Delhi High Court).