This article has been published by the Indian Business Law Review, in Volume 2 Issue 2.

I. Background

Employee stock option plan or employee stock ownership plan (“ESOP Plan”) is an incentive strategy by which shares or similar equity interests of the employer entity and/or any of its group companies are offered to the employees, subject to vesting and exercise conditions tied typically to continued employment and fulfilment of agreed upon performance matrix and/or time-based conditions. By way of cross-border ESOP Plans offering global incentives, Indian resident employees are increasingly being granted employee stock options of the offshore parent company and/or group company(ies) of the Indian employer entity, with the right to subscribe to the shares or other equity interests of the issuing offshore entity pursuant to exercise of such options on vesting (“ESOPs”). Please also refer to the article published in Volume 2, Issue 1 (available at: https://iblronline.com/volume-2-issue-1/) covering regulatory analysis of overseas rollover investment by Indian founders as part of incentivizing founders/key employees of Indian entities with overseas parents.

The Foreign Exchange Management Act, 1999 and the rules and regulations issued thereunder, such as the Foreign Exchange Management (Overseas Investment) Rules, 2022 (“OI Rules”), the Foreign Exchange Management (Overseas Investment) Regulations, 2022 (“OI Regulations”), and the Foreign Exchange Management (Overseas Investment) Directions, 2022 (“OI Directions”) (collectively, the “OI Regime”) govern the ESOPs granted by offshore entities to Indian resident employees (“Indian Employees”) employed with the Indian group entity (“Indian Employer”).

II. Grant of ESOPs and acquisition of Shares under ESOP Plans

• Offshore entities granting ESOPs: The OI Rules permit grant of ESOPs by offshore entities to Indian Employees, provided that: (a) such individuals are employees or directors of the Indian office/ branch or subsidiary of such offshore entity, or an Indian entity in which such offshore entity holds direct or indirect (through a special purpose vehicle or a step-down subsidiary) equity interests, and (b) the ESOPs are offered by the issuing offshore entity (“Issuing Entity”) “globally on a uniform basis.”

While there is no specific guidance from the Reserve Bank of India (“RBI”) on the interpretation of “globally on a uniform basis,” the spirit of this rule appears to suggest that the underlying ESOP Plan should not merely be aimed towards the Indian Employer or the Indian Employees but should be a global scheme applied uniformly across all applicable jurisdictions where such Issuing Entity and/or its group entity(ies) have presence and roll out such stock option schemes. Whilst untested with the RBI or an Indian court, any minor deviations from the overall ESOP Plan, in order to meet local law and jurisdictional requirements, should not, in our view, take away the essence that such ESOP Plan is not aimed towards India alone, is offered globally, and predominantly applied on a uniform basis. However, in the absence of specific guidance, any deviations from the general norm should be examined and addressed on a case-to-case basis.

• Categorization of ESOP Investment: The OI Rules provide that Indian Employees may acquire shares or similar equity interests of permissible offshore entities via an ESOP Plan (“ESOP Shares”) and such overseas investment by Indian Employees for less than 10% of the total equity capital (whether listed or unlisted) of the Issuing Entity, without acquisition of any control, is classified as Overseas Portfolio Investment (“OPI”). Therefore, unlike the Overseas Direct Investment (“ODI”) route (which otherwise applies to (a) any overseas investment in an unlisted entity, and (b) 10% or more investment or acquisition of control in an offshore listed entity), the OPI route allows investments by Indian resident individuals in offshore entities that are engaged in “financial sector activity.” This becomes critical from an ESOP perspective, given that typically the Issuing Entities are holding (TopCo) entities, which would otherwise be characterized as being involved in financial sector activity under Indian law.
• Investment Amounts and LRS Limits: While there is no cap on the consideration amount that can be remitted by an Indian Employee for acquisition of the ESOP Shares in terms of the ESOP Plan, any such remittance will be counted towards the overseas investment cap imposed on an Indian resident individual under the Liberalized Remittance Scheme (“LRS”) issued by the RBI (currently, at USD 250,000 per financial year). For instance, if the Indian Employee is required to remit USD 300,000 towards acquisition of the ESOP Shares, whilst such remittance will be permitted, such individual’s LRS limit for the concerned financial year will stand exhausted and such individual may not be able to make any other overseas investments (other than via the ESOP route) for that particular financial year.
• Permissible Modes of Payment: To subscribe to the ESOP Shares upon exercise of the ESOPs, the Indian Employee can make use of the permissible modes of payments to remit the consideration amount for such subscription, directly to the Issuing Entity, through two key modes: (a) ordinary banking channels, and (b) funds held in an account maintained in accordance with the Foreign Exchange Management Act, 1999. Except for the aforementioned modes of payments, any other financing structures, such as provision of offshore loans to the Indian Employees for subscription of the ESOP Shares, are not permitted under the OI Regime.

• Reporting for acquisition of ESOP Shares: The reporting requirement gets triggered upon issuance of the ESOP Shares pursuant to exercise by the Indian Employees in accordance with terms of the ESOP Plan. Prior to coming into effect of the OI Regime on August 22, 2022, the Indian Employer was required to file an annual report in Form ‘ESOP Reporting’ with the RBI through its authorized dealer bank (“AD Bank”) and ‘cashless exercise’ of the ESOPs by Indian Employees was exempt from such reporting.

However, under the OI Regime, a bi-annual reporting in Form ‘OPI’ has been introduced, which must be filed by the Indian Employer within sixty (60) days from the relevant half-year end in which the exercise is made (i.e., March or September of a given financial year, as the case may be) through the Indian Employer’s AD Bank. The Indian Employee acquiring the ESOP Shares under the ESOP Plan continues to remain exempt from the requirement to make any separate filings. In brief, Form OPI requires details of the exercise, ESOP investment amount, details of the ESOP Shares being acquired; number of Indian Employees acquiring the ESOP Shares; and the Issuing Entity. Given that there is no exemption from reporting for ‘cashless exercise’ of the ESOPs under the OI Regime, a ‘NIL’ Form OPI will have to be filed by the Indian Employer for cashless exercise where no money has been remitted by the Indian Employee(s).

Failure to make the reporting within the stipulated timeline would attract a late submission fee (“LSF”) of INR 7,500 per delayed filing, where the filing is finally made within three (3) years from the due date. In the event of a delay beyond three (3) years, a compounding application will need to be filed by the Indian Employer with the RBI to rectify such delay, whereupon RBI could impose a compounding penalty of INR 10,000 per delayed filing plus a penalty of up to INR 200,000 (depending on the amount and nature of contravention involved). Whilst the LSF process is quicker, disposal of a compounding application by the RBI could take up to six (6) months or more.

III. Transfer of ESOP Shares

ESOP Shares acquired by the Indian Employees under the ESOP Plan can be transferred by way of: (A) sale to a third party, or (B) repurchase by the Issuing Entity.

A.  Sale of ESOP Shares to a Third Party

• Conditionalities for Third-party Sale: The Indian Employee may transfer the ESOP Shares, pursuant to sale of such shares to a third party (whether a person resident in India or a person resident outside of India) in accordance with the OI Regime, subject to such shares being issued and held in accordance with the OI Regime. Prior approval of any competent authority(ies) as per the applicable Indian laws or laws of the host country of the Issuing Entity may be required, in case of transfer of the ESOP Shares in special cases of a merger, amalgamation, demerger or liquidation of the Issuing Entity (if applicable).

Transfer of the ESOP Shares to a third party must be undertaken on the basis of the fair market value of such shares (“FMV Consideration”), which must be ascertained based on a valuation report prepared by a chartered accountant (or similar professional) as per any internationally accepted pricing methodology for valuation on arm’s length basis, prior to the transfer. Further, payment of deferred consideration for sale of such ESOP Shares (which are considered as investments made under the OPI route) is not permissible. Therefore, the entire amount of FMV Consideration must be paid to the selling Indian Employee(s) in its entirety at the time of such transfer. As mentioned, any offshore financing arrangements, including adjustment to the consideration amount, such as a set off, or payment of consideration being routed to the Indian Employer, are not permitted under the OI Regime.

• Reporting Requirement: Upon transfer of the ESOP Shares, the Indian Employer will be required to file Form OPI with the RBI in the manner and timeline set out above.
• Repatriation of Sale Proceeds: If the consideration for sale of the ESOP Shares, is received in a non-Indian bank account of the Indian Employee, such sale proceeds should be repatriated to India within ninety (90) days of receipt, unless the same is being reinvested in accordance with the OI Regime before expiration of the aforesaid period. Generally, this repatriation requirement is automatically met if the consideration is paid into the Indian bank account of the selling Indian Employee. Ideally, the consideration should be paid into the same bank account through which the Indian Employee remitted funds for acquisition of the ESOP Shares.

B.  Repurchase of ESOP Shares by the Issuing Entity

i.) Conditionalities for Repurchase: Repurchase of the ESOP Shares by the Issuing Entity is permitted under the OI Regime, subject to satisfaction of the following conditions:

• such repurchase should be permitted under and must be undertaken in accordance with the terms of the initial offer documents (for example, ESOP Plan, grant letter, etc.);
• the ESOP Shares should have been issued in accordance with the OI Regime;
• requisite filings for acquisition of the ESOP Shares should have been made;
• prior approval of the competent authority(ies) at the host country of the Issuing Entity, if required, should have been sought for such repurchase; and
• all other applicable conditions as applicable in the case of a third-party sale (set out above at Section III(A)), including payment of FMV Consideration, should be met.

ii.) Other Requirements: Reporting and repatriation requirements, as set out above at Section III(A) are also applicable for repurchase of the ESOP Shares by the Issuing Entity.