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The taxation of Employee Stock Option Plans (ESOPs) can be intricate, particularly for Indian residents who become Non-Resident Indians (NRIs). This article explores the key considerations for NRIs related to taxation and repatriation of their ESOP holdings.
ESOP is a benefit programme for employees that allows them to buy shares of their company at a specified price. To understand how ESOPs work, let's go through an example.
Amit, an employee at a leading company, receives 100 ESOPs as part of his compensation package with the below particulars:
- Grant date: January 1, 2019
- Number of options: 100
- Exercise price: ₹50 per share (discounted price Amit can buy them at)
- Vesting period: Three years (time it takes for Amit to earn ownership of these ESOPs)
- Exercise period: Two years (window to purchase after vesting)
On the vesting date, January 1, 2022, all 100 options will fully vest. After that, Amit will have two years to exercise his option and buy shares at the exercise price of ₹50. If he doesn’t do so, the options will expire.
Please note, the tax treatment of the taxable value of perquisites on the exercise of options will be the same for resident and Non-Resident Indian (NRI) taxpayers.
Let us understand the taxation and repatriation rules of ESOPs in more detail.
Tax implications on ESOPs
As per the Indian income tax laws, the taxation of ESOPs is triggered at two stages:
1. At the time of exercise of options as a perquisite
You will be taxed on the notional profit you make when you exercise your ESOPs. The taxable amount is the difference between the share's prevalent Fair Market Value (FMV) on the exercise date and the exercise price paid by you.
Taxable value = FMV of the share on exercise date - Exercise price paid
Let’s say that on On September 1, 2023, Amit decided to exercise the option. The FMV of his company’s shares on the exercise date was ₹90, and the exercise price for him was ₹50 per share. Thus, the taxable value would be ₹40 (₹90 - ₹50) per share. This will be taxed as per the income tax slab rate applicable to the Amit.
Did you know?
From April 1, 2021, if you receive ESOPs from a qualifying start-up as outlined in section 80-IAC of the Income Tax Act, 1961, you will have to pay tax on the benefit derived upon exercising the options within 14 days of the earliest of the following events: Expiry of five years from the year of allotment of ESOPs; or Date of sale of the ESOPs by the employee; or Date of termination of employment.
2. At the time of sale of shares as capital gains
When you sell the allotted shares, any gains derived are subject to capital gains tax in India. The taxable value is calculated as follows:
Capital gains = Sale price of shares - FMV of shares on the exercise date
The table below summarises taxation rules related to capital gains:
Type of shares | Holding period* | Type of capital gains | Tax rate |
---|---|---|---|
Unlisted shares |
> 24 months |
Long-term capital gain |
12.5% without indexation |
Upto 24 months |
Short-term capital gain |
Applicable slab rates |
|
Listed shares** |
> 12 months |
Long-term capital gain |
12.5% on capital gains > ₹1,25,000*** per year |
Upto 12 months |
Short-term capital gain |
20% |
* The holding period is calculated from the date of allotment of shares to the date of sale of shares.
**Provided Securities Transaction Tax (STT) is paid at the time of acquisition and sale of shares.
*** The ₹1,25,000 limit applies to the total long-term capital gains derived from the sale of listed securities in the relevant financial year.
Further, applicable surcharge and cess will be levied on the capital gains tax outlined above.
However, in case there is a capital loss from the sale of shares, it can be carried forward for eight financial years (April–March) immediately following the financial year in which the loss was first computed.
Coming back to our example, let’s assume that Amit decided to sell his shares on March 1, 2024, at ₹120 per share. Since the FMV of his company’s shares on the exercise date was ₹90, the purchase price for calculating the capital gain would be ₹90.
The resulting capital gain would be:
Capital gain = Sale price of shares - FMV of shares on the exercise date
i.e., ₹120 - ₹90 = ₹30 per share
As Amit held the shares only for six months, the gain qualifies as a short-term capital gain, and he will be taxed at a flat rate of 15% and applicable surcharge and cess.
Repatriation of sales proceeds from ESOPs
Once you sell your ESOP shares, the sale proceeds may be credited to your Non-Resident External (NRE) or Non-Resident Ordinary (NRO) account. Before you repatriate these funds overseas, there are two critical factors to consider:
- Your residential status on the date of exercising the option
- The account used for exercising the option
If you exercised the ESOPs before becoming an NRI, you can repatriate up to 1 million USD in a financial year (April–March).
However, if you exercised the ESOPs after becoming an NRI and you used your:
- NRE account, the proceeds from your investments are fully repatriable
- NRO account, you can repatriate up to USD 1 million cumulatively for all NRO accounts held in India per financial year (April–March), subject to necessary documentation and tax compliances.
Scenario 1: ESOPs exercised as an Indian resident
Amit was granted 100 shares as ESOPs. He was an Indian resident on September 1, 2023, when he exercised the option. He became an NRI later and subsequently sold his shares. Since he was an Indian resident at the time of exercising the option, the sale proceeds from such shares will be held in an NRO account. He can repatriate only up to USD 1 million cumulatively per financial year (April–March).
Scenario 2: ESOPs exercised as an NRI
Once Amit became an NRI, he received an additional 50 shares as ESOPs. He used his NRE account to exercise the option for these 50 shares. In this case, the sale proceeds from such shares are fully repatriatable as he has used his NRE account to exercise this option.
However, if Amit had used his NRO account to exercise the option for these 50 shares, then he could have repatriated only up to USD 1 million cumulatively per financial year (April–March) from the sale proceeds of such shares.
Claiming benefits under DTAA
For NRIs facing taxes on their ESOP benefits, there is potential relief available through Double Taxation Avoidance Agreements (DTAA) established between India and their country of residence.
DTAA can help you avail of treaty benefits in India. To claim these benefits, you have a valid Tax Residency Certificate (TRC) and other relevant documents.
Understanding the ESOP sale process and documentation
For listed companies
Holding ESOPs as a resident Indian allows you to sell them through your existing resident trading account if they are listed on registered stock exchanges like the National Stock Exchange (NSE) or the Bombay Stock Exchange (BSE). To read more about stock market investments by NRIs, click here.
Once you become an NRI, you will need to transfer these holdings to an NRI demat account and you can subsequently sell these shares through your NRI trading account. To know more about NRI demat and trading accounts, click here.
Please note, you must use a Portfolio Investment NRI Scheme (PINS) designated account for trading purposes. To know more about PINS, click here.
For unlisted companies
Shares of an unlisted company can be transferred only in the manner provided in the exit mechanism of the company’s ESOP plan.
While selling the shares and determining the taxability, you will need:
- The ESOP plan from your employer
- The allotment letter stating the allotment details and the exercise price and
- A TRC to avail of the benefits under DTAA
You should consult a tax practitioner to evaluate the applicable tax laws and claim the potential DTAA benefits.
Conclusion
NRIs face specific challenges related to the taxation and repatriation of their ESOP holdings. It is important to understand the vesting period, exercise window, the holding period and tax triggers for ESOPs. In case of NRIs, the residential status at the time of exercising the option and the type of bank account (NRE/NRO) used determines the repatriation rules. An NRI demat account is necessary for selling shares acquired through ESOPs on a recognised stock exchange. Potential tax relief is available under DTAA on the sale of such shares. You should consult a tax professional for more details.
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