A Guide to ESOP Taxation in India for NRIs

ESOP (Employee Stock Option Plans) is a benefit scheme that offers employees the right to buy company shares at a predetermined price, usually after a vesting period. It offers employees an opportunity to own company shares at a lower price and aligns their growth with the company's success.

ESOPs trigger taxation at two stages: when the option is exercised as a perquisite and when the shares are sold as capital gains. However, NRIs can claim tax relief under a DTAA by furnishing a valid TRC and other required documents.

Additionally, the proceeds earned from selling ESOP shares may be credited to either your NRO, from which you can repatriate only up to $1 million USD, or your NRE account, from which the amount is fully repatriable. In this blog, we will discuss more about NRI ESOP taxation.

What are ESOPs? 

ESOPs (Employee Stock Option Plans) are a benefit scheme where companies allow employees to buy shares at a predetermined price after a certain period. Instead of being granted as shares immediately, these shares vest over a specific period. After the vesting period, the employees may exercise their options to convert them into actual shares. Let's understand how ESOPs work with an example of Lokesh:

Lokesh works at a leading company and receives 100 ESOPs as part of his compensation package with the following particulars:

• Grant Date: 1st of January, 2020 
• Number of Options: 100
• Exercise Price: INR 50 per share (discounted price at which Lokesh can buy them)
• Exercise Period: Two years (window to buy after vesting)
• Vesting Period: Three years, which is the time it will take Lokesh to earn ESOP ownership.

Now, on January 1, 2023 (vesting date), all 100 options will fully vest. After that, Lokesh will have two years to exercise his option and purchase the shares at the exercise price, which is INR 50. The options will expire if he doesn't purchase the shares. 

Remember that the taxable value of perquisites on the exercise of options will be taxed the same for both resident and non-resident Indian (NRI) taxpayers. 

ESOPs Tax Implications

ESOPs trigger taxation at two stages according to the Indian income tax laws:

At the Time of Exercising the Options as a Perquisite

When you exercise your ESOPs, you will be liable to pay tax on the national profit you earn. The difference between the share's prevernal Fair Market Value (FMV) on the exercise date and the exercise price paid by you is the taxable amount. It means:

• Taxable Value = FMV of the share on exercise date - Exercise price paid. 

Let's say that Lokesh chose to exercise the option on the 1st of September, 2024. On the exercise date, the FMV of his company's shares was Rs. 90, and the exercise price for him was Rs. 50 per share. So, if we calculate, the taxable value would be Rs. 40. 

• Rs. 90 (FMV of the share on exercise date) - Rs. 50 (Exercise price paid) = Rs. 40 (Taxable Value)

This value will be taxed according to the income tax slab rate applicable to Lokesh. 

At the Time of Selling Shares As Capital Gains

Any gains earned after selling the allotted shares will be subject to capital gain taxation in India. The taxable value will be calculated as:

• Capital Gains = Sale Price of Shares - FMV of shares on the exercise date

The table below lists the taxation rules associated with capital gains:

*The holding period is computed from the allotment date of shares to the sale date of shares. 

** If Securities Transaction Tax (STT) is paid at the time of acquiring and selling the shares. 

*** The Rs. 1,25,000 limit is applicable to the overall long-term capital gains earned from the sale of listed securities in the relevant financial year. 

Additionally, applicable surcharge and cess will be charged on the capital gains tax mentioned above. However, you can carry forward capital loss from selling the share (if there is any) for 8 financial years (April- March) immediately following the financial year in which the loss was calculated first. 

Again, considering the example, suppose Lokesh decided to sell the shares on 1st March, 2024, at Rs. 120 per share. The FMV of his company's share on the exercise date was Rs. 90, and the purchase price for computing the capital gain would be Rs. 90. Then, the resulting capital gain would be as per the formula:

•  Rs. 120 (Sale price of shares) - Rs. 90 (FMV of shares on the exercise date) = Rs. 30 per share (capital gain)

Since Lokesh held the shares only for six months, the gains will be treated as short-term capital gain. It means he will be taxed at a flat rate of 20%, with applicable surcharge and cess. 

Repatriating Sale Proceeds from ESOPs

The proceeds acquired from selling your ESOP shares may be credited to your Non-Resident External (NRE) or Non-Resident Ordinary (NRO) account. Consider the following two key factors before repatriating these funds:

• Account you used for exercising the option, and 
• Your residential status on the date of exercising the option

You can repatriate up to $1 million in a financial year if you exercised the ESOPs before transitioning to the NRI status. However, if you exercise the ESOPs after becoming an NRI, and you used your:

• NRE account, then the proceeds earned from investments are fully repatriable. 
• NRO account, then there is a limit on repatriation. You can repatriate only up to 1 million USD in total for all NRO accounts held in a financial year (April-March). This is subject to certain necessary documents and compliance with the tax laws. 

Example 1: ESOPs exercised before becoming an NRI

Lokesh received 100 shares as ESOPs, and he exercised the option on 1st September, 2023, when he was an Indian resident. Later, he became an NRI and sold his shares. Now, the sale proceeds from such shares will be held in an NRO account, as he was an Indian resident when exercising the option. He will be allowed to repatriate only 1 million USD overall per financial year (April-March). 

Example 2: ESOPs exercised after becoming an NRI

Lokesh received an additional 50 shares as ESOPs after becoming an NRI, and he used his NRE account to exercise the option. Since he used his NRE account to exercise the option, the sale proceeds acquired from the shares can be repatriated fully. 

Claiming DTAA Benefits 

NRIs can claim tax relief on their ESOP benefits through the DTAA (Double Tax Avoidance Agreement) between India and their country of residence. You can claim treaty benefits in India under the DTAA agreement by providing a valid Tax Residency Certificate (TRC) and other relevant documents. 

ESOP Sale Process and Documentation

The rules for the ESOP sale process may vary for both listed and unlisted companies:

For Listed Companies

You can sell your ESOPs as a resident Indian through your existing resident trading account if they are listed on registered stock exchanges like the National Bank Exchange (NSE) or the Bombay Stock Exchange (BSE). You must transfer these holdings to an NRI demat account after becoming an NRI. Later, you call these shares using your NRI trading account. 

For trading purposes, you must have a portfolio investment NRI scheme (PINS). 

For Unlisted Companies

You can transfer the shares of an unlisted company only in the manner specified in the company's ESOP plans' exit mechanism. When selling the shares and calculating your tax liability, you will need:

• ESOP plan from your employer
• A Tax Residency Certificate to enjoy benefits under the DTAA. 
• The allotment letter, which contains the exercise price and details of allotment.

To Conclude

NRIs face various challenges with their ESOP holdings, including taxation and repatriation issues. They must understand the vesting period, exercise window, holding period, etc., to navigate ESOPs. The ESOP repatriation rules depend on the residential status of the individual at the time of exercising the option and the bank account type used. 

For extra assistance and details, consulting a tax professional at Savetaxs can be beneficial. At Savetaxs, we have an entire team of experts who carry years of experience and good knowledge regarding NRI taxation and financial matters. They can help you resolve any issues easily without any stress. Connect with us today, as we are serving our clients 24/7 across the globe.