Taxability of ESOP, ESPP and RSU received from Indian or Foreign Company under Income tax Act, 1961

Explore the tax implications of Employee Stock Option Plans (ESOP), Employee Stock Purchase Plans (ESPP), and Restricted Stock Units (RSU) received from Indian or foreign companies under the Income Tax Act, 1961. Understand the treatment, valuation, and disclosure requirements for unlisted shares in the context of taxation. Stay informed to ensure accurate filing of income tax returns and compliance with regulatory obligations.

Of late it has become trend of offering shares of the Company to the top management employees in order to retain them. Many multinational companies offer shares of their holding company based out of India to their Indian employees as a part of employment contract etc. Also, such foreign company sells part of shares to recover the tax payable on such shares. In this article we will understand treatment of taxability of ESOP, ESPP and RSUs under different scenarios.

What is ESOP, ESPP and RSUs:

Employee Stock Option Plan (ESOP):

Under this share compensation system, the employee has the option to purchase shares of the employer Company, at a pre-determined price, but at a future date.

For example – Let’s say you join a company in 2021. Now the employer may offer your 10,000 ESOPs which vest when you complete 3 years in the company at a pre-decided price of Rs 100 per share. So, if you remain with the company for 3 years, i.e., till 2024 and if the share price is Rs 175, you will get the option to purchase up to 10,000 shares at earlier committed price of Rs 100 and irrespective of the prevailing market price at the time.

Restricted Stock Unit (RSU):

In the case of RSUs, the employees get shares of the employer Company after a vesting period without making any payment for the same. A vesting period is basically the duration for which the employee must wait to claim the shares allotted by the company

Let’s say you join the company at the start of 2022; your employer may offer you RSU of 5,000 shares that will start vesting 25 percent every year after completion of the second year. So, this means that in the first tranche, you will get 25 percent, or 1,250 shares of the company in 2024. After that, you will get 1,250 shares in 2025, 2026 and 2027. If you stay in the company till 2027, you will get all 5,000 shares. If you quit in between, let’s say in 2025, then you lose out on the shares which would have vested in later years.

Employee Stock Purchase Plan (ESPP):

Under ESPP, employer Company offer regular ongoing purchase of shares at a pre-decided discount to the prevailing market price. It is like a sort of monthly SIP that the employee can do in their employer Company’s shares.

A company may allow you to invest 10-15 percent of your monthly salary via ESPP in company shares at a 20 percent discount. So, if you earn Rs 1 lakh monthly, then you can invest Rs 10-15,000 via an ESPP. And suppose the company share is trading at Rs 200, then you get it at a 20 percent discount, i.e., at Rs 160 per share.

Exercising an Option: At the end of the vesting (lock-in) period, the employee can opt to purchase the shares, which is referred to as exercising the Option.

Taxability at the time of exercising the option or buying the shares:

Treatment of taxing remains the same in all the above three cases from Indian Income tax Law perspective. The same is taxable in the hands of employees as a perquisite under the head Income from Salary on the date of exercising the option. Valuation of perquisite will be as per Section 17(2)(vi) read with Rule 3(8) and Rule 3(9) of the Income tax Law and the same is as under:

Perquisite Value = FMV of Share on exercise date (-) Exercise Price/price paid by an employee to the employer

Sr. No.	Cases	FMV on the date of exercise shall be	Rule Reference
1	Shares are listed on one Indian Stock Exchange	Average price of the day shall be FMV	3(8)(ii)
2	Shares are listed on more than one Indian Stock Exchange	Average price of the day on Stock Exchange which records highest volume shall be FMV	First Proviso to Rule 3(8)
3	No Trading on Stock Exchange on exercising date on which shares are listed	Closing price of closest date preceding to the date of exercising the option on one Stock Exchange	Second Proviso to Rule 3(8)
4	No Trading on any Stock Exchanges on exercising date where shares are listed on more than one India Stock Exchange	Closing price of closest date preceding to the date of exercising the option on any Stock Exchange where highest volume is recorded on any Stock Exchage	Second Proviso to Rule 3(8)
5	Unlisted Equity Shares	Price determined by the Merchant Banker	3(8)(iii)
6	Any other specified security	Price determined by the Merchant Banker	3(9)

In case Indian MNC is allotting shares of their holding company located outside India, such shares are valued based on the certificate issued by respective country’s custodian/broker of shares and based on such certificate perquisite value is calculated and the same is taxed in the hands of employees and tax payable on such shares is either recovered in cash from employees or deducted in the form of shares which are then sold in open market to recover tax amount.

What if tax is deducted in the form of shares:

For example: 100 Shares were allotted at Rs. 10 (FMV as on the date of exercise), exercise price paid by an employee is Rs. 2 per share in Year 1. Company sold 20 shares @ Rs. 11 in the open market to recover the TDS in Year 1. Computation of Perquisite value and capital gain in Year 1 will be as under:

Computation of Perquisite Value		Computation of Capital Gain
Particulars	Amt in Rs.	Particulars	Amt in Rs.
Perquisite Value		Sale Consideration (Note 1)	220
FMV on the date of exercise	10	(20 Shares * 11)
Less: Exercise Price Paid	(2)	Less: Cost of Acquisition	(200)
Perquisite Value per share	8	FMV considered for Perquisite
No. of Shares	100	(20 Shares * 10)
Taxable Value of Perquisite	800	Short Term Capital Gain	20

Note1: for better understanding selling price taken as Rs. 11, otherwise it will be same as cost price only because shares will be sold immediately.

Taxability at the time of selling such shares subsequently:

This event is taxable under the head Income from Capital Gain. As per section 49(2AA) FMV considered for calculating perquisite value at the time of exercising the option will be the cost of acquisition for the purpose of computation of capital gain.

Further in case where tax payable is deducted in the form of shares, employee will be allotted remaining shares. Cost price of such share will be FMV of each share considered under the head Income from Salary.

Continuing the above example, suppose Employee sold balance 80 shares @ 18 in Year 3, Computation of Capital Gain will be as under:

Computation of Capital Gain in Year 3
Particulars	Amt in Rs.
Sale Consideration	1,440
(80 Shares * 18)
Less: Cost of Acquisition	(800)
FMV considered for Perquisite calculation
(80 Shares * 10)
Long Term Capital Gain	640

Important Judicial Pronouncements

In the case of Anil Bhansali vs ITO (ITA. No. 220/Hyd/2014) Hon’ble Hyderabad ITAT held that taxation of stock option income derived by an employee while working in two countries which provides, employment benefit attributable to the stock option should be considered to be derived from a particular country in proportion of the number of days during which employment has been exercised in that country to the total number of days during which the employment services from which the stock option is derived is exercised. Only because the stock awards were treated as part of salary in the TDS certificate issued in Form No.16 issued by employer, for that reason alone, it cannot be concluded that the entire stock amount is taxable in India. Therefore, without ascertaining how much of the SOTP is attributable to services rendered in India, the entire amount cannot be made taxable only because the money was received in India. Therefore, we are of the view that the assessee having residential status of ‘not ordinarily resident’, only that portion of the stock awards and SOTP attributable to services rendered in India can form part of total income for the impugned assessment year.

In the case of Unnikrishnan V S vs ITO, International Taxation 4(3)(1), Mumbai (ITA Nos. 1200 and 1201/Mum/2018) Hon’ble Mumbai ITAT held that

(i) ESOP benefits vested and granted to an assessee when he was resident and in consideration for services rendered in India is taxable even though the assessee is a non-resident in the year of exercise. S. 17(2)(vi) decides the timing of the income to be the year of exercise of the ESOPs but does not dilute or negate the fact that the benefit had arisen at the point of time when the ESOP rights were vested and granted.

(ii) Article 15 of the India-UAE DTAA permits taxation of ESOP benefit, which is included in the scope of the expression “other similar remuneration” appearing immediately after the words “salaries and wages”, in the jurisdiction in which the related employment is exercised. Thus, an assessee who gets ESOP benefits in respect of his service in U.A.E. and he exercises these options at a later point of time, say after returning to India and ceasing to be a non-resident, will still have the treaty protection of that income under article 15(1). Conversely, when the assessee gets the ESOP benefit on account of rendering services in India, he cannot have the benefit of article 15 in respect of the said income.

Other Important aspects to be kept in mind in respect of shares received from Foreign Company while filing Income tax Returns in India (applicable for Resident Taxpayers):

1. Since these shares are not listed in India, a separate disclosure is required in ITR form under PART A – General in respect of unlisted shares. One may not report under this clause on the basis that these are shares listed outside India and specific schedule in ITR form covers the same;

Details required to be reported – Name and Type of Company, Opening Balance (Number and Value) of Shares, Shares acquired and transferred during the year and Closing Balance (Number and Value).

2. Schedule FA – Details of Foreign Assets and Income from any Source Outside India specifically requires resident taxpayer to disclose the details of foreign assets including shares, debentures, bank accounts, immovable property and other assets. This schedule also requires reporting of income earned from such foreign assets.

 Resident taxpayer holder of shares of foreign company received under Option plan etc should report details of such holdings as well as dividend income earned from such holding during the previous year relevant to the assessment year for which ITR to be filed;

3. In case tax is deducted by such foreign company on dividend income, one needs to file Form 67 to claim the credit of such foreign taxes and appropriate disclosure is also required in the ITR form;