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Taxation of Employee Stock Options
Privileged & Confidential
Presented by Gouri Puri Amarchand & Mangaldas & Suresh A. Shroff & Co.
September 4, 2014
Privileged & Confidential | 2
Contents
▪ Introduction to Employee Sock Option Plans (“ESOPs”)
▪ Overview of Indian legal and regulatory framework
▪ Tax treatment of ESOPs
▪ Key tax issues
▪ Key takeaways
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Introduction to ESOPs
Equity based incentive plans
Employee stock option plan ✓
Employee share purchase scheme
Restricted stock units/ restricted stock
Stock appreciation rights
Phantom Stock
ESOP is a right given to employees to purchase shares of a company at a future date at a pre-determined price
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▪ Key Features of an ESOP
- ESOP is a right and not an obligation to purchase shares
- Right to purchase shares at a future date
- The price of shares is fixed today irrespective of change in market price – in the money and out of the money options
- Option upon exercise converts into equity shares
- ESOP contemplates a four stage process:
Introduction to ESOPs (Contd.)
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▪ Indian ESOPs
- SEBI (Employment stock Option Scheme & Employee Stock Purchase Scheme) Guidelines, 1999
- Companies Act, 2013
- Exchange control regulations
- Income-tax Act, 1961 (“IT Act”)
▪ Cross border ESOPs
- Exchange control regulations
- IT Act
Overview of legal and regulatory framework
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Tax Treatment of ESOPs
Obligation to deduct tax at source on perquisite income under section 192 of Income Tax Act
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▪ Cross border income tax issues
- Timing mismatch in taxing the employment benefit
- Distinguishing employment income from capital gains
- Difficulty in determining to which services the option relates
- Employment services provided in more than one country
- Compliance Issues
- ACIT v. Robert Arthur Keltz, ITA No. 3452/Del/201
- Proportionate taxes attributable to services rendered in India
- Place of rendition of service between grant - vesting – exercise
▪ Lack of clarity on tax treatment on cancellation/ replacement of options - Capital gains v. employment income - differentiation in source rules, tax rates and withholding tax
liability
- Sumit Bhattacharya v. ACIT – “fruits of employment” theory
Key tax issues
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▪ Obligation to deduct TDS
- In case of ESOPs granted to Indian employees under global ESOP plan, whether obligation to deduct tax is on actual payer (foreign affiliate or parent issuing shares) or employer (Indian Company)
- Section 204 of the IT Act – person responsible for making payment is employer for salary income
- In case of ESOPs issued under the ESOP trust mechanism, is there an obligation to deduct tax – Wipro ruling
Key tax issues
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▪ Deductibitly as business expenditure
- Accounting treatment and SEBI guidelines permits amortization
- Tax deductibility to be determined Section 37 of the IT Act
- Divide in judicial opinion
• Allowed: SSI Ltd v. DCIT, Accenture India Pvt. Ltd. v. ACIT, Biocon v. DCIT
• Disallowed: Ranbaxy Laboratories Ltd. V. DIT
- Whether discount is allowable tax expense?
- When can such discount be claimed as an expense and how much?
- Is any subsequent adjustment needed to discount amount claimed as an expense?
- Cash payout by Indian company to foreign parent/ affiliate of discount amount incurred by foreign parent/ affiliate – whether deductible by Indian company?
- No cash payout by Indian company to foreign parent/ affiliate of discount amount incurred by foreign parent/ affiliate – whether deductible by Indian company?
Key tax issues (Contd.)
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- Indian company issues shares to employees of foreign subsidiary at discount – whether deductible by Indian company? Transfer pricing implications, if any?
- Deductibility as business expenditure when shares transferred to ESOP trust? - Deductibility in cases of restricted stock and shares issued under employee share purchase plan?
▪ Taxation of ESOP trusts - Shares received by ESOP trusts below book value – section 56(2)(viia) of IT Act? - Taxation under sub-clause (iv) of proviso to section 164 of IT Act - Taxation of dividends, interest and capital gains
▪ Taxation of restricted stock and restricted stock units - Indian law treats allotment of shares as taxable event - Infosys ruling and WIPRO ruling
▪ Deduction of tax at source under cashless exercise of options - Deduction from regular salary - Retention of shares for payment of taxes
Key tax issues (Contd.)
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▪ Tax policy on tax consequences of ESOP for all stakeholders should be clear and certain to incentivize equity based compensation plans
▪ Clarity in law needed on tax issues arising from cross border ESOPs
▪ Market practice for employers for deducting tax on salary is to take a conservative stance – full disclosure to employees on tax issues
▪ Clarity in law needed on deductibility of discount on shares issued pursuant to ESOPs
▪ Clarity in law needed on taxation of ESOP trusts and related issues
▪ Clarity in law needed on taxation of other equity based incentive plans – restricted stock units
Key takeaways
Thank You
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