Approach Document: Treatment of Employee Stock Option Plan (ESOP) for internationally mobile employeesBy Rajendra Prasad Sappa, Chief Delivery Officer, AscentHR

Background

Multinationals worldwide frequently offer shares under ESOP to their employees as part of their reward and retention strategy. ESOP is a form of remuneration and hence is taxable as such in hands of the employee. In accordance with OECD guidelines, the taxability of ESOP in India depends on where employment is exercised and the period of service for which ESOP has been granted. ESOP taxability has been a subject matter of litigation in India over the past years, however, a ruling of the Income tax Appellate Tribunal has helped to clarify the treatment.

Options granted under ESOP are taxable in the jurisdiction that follows the OECD principles for taxing share awards, where they are earned and not where the taxpayer is located when they exercise the option. To determine the question of where ESOP gains are earned for the purposes of Indian tax, the general practice is to consider where services are rendered during the vesting period.

Tracking the employment tax obligations of share awards for internationally mobile employees can be complex to administer.

In addition to the taxation of the individual in respect of an award under an ESOP, there may be tax liabilities and reporting obligations on the employer.  It is therefore important for the employer to have appropriate record keeping procedures in place in relation to the ESOP, the personal tax position of the relevant employee, and the locations where the employee has worked.

The purpose of this document is to outline the approach for handling the taxation of Employee Stock Option Plan (ESOP) income, specifically addressing the income split between India and the US, and the associated tax implications for an employee who holds stock options in a company operating in both countries.

The given below approach applies to employees who are working in both India and the US and are classified as Resident and Ordinarily Resident (ROR) in India for the current financial year. The objective is to determine how the ESOP income should be apportioned between the two countries and understand the tax obligations in both jurisdictions. 

ESOP Income Split and Taxation

Income Split Between India and the US:

• The ESOP income will be divided based on the employee’s tenure, vesting schedule, and work performed in both India and the US.
• Indian Portion: Any portion of the ESOP income attributable to the period the employee worked in India will be considered a perquisite and taxed as income from employment in India. This portion will be included in the employee’s salary for Indian tax computation and reflected in the Form 16.
• US Portion: The ESOP income related to the employee’s tenure in the US must be considered by the employee while filing their Indian tax return. The employee is required to declare this income in India, and it will be subject to tax in India, based on their residential status as ROR.

Treatment of US ESOP Income

Option 1 – Temporary Inclusion in India Payroll:

• The US portion of the ESOP income can be temporarily included in the India tax computation, based on the employee’s residential status as ROR.
• The taxes related to the US portion will be recovered through the India payroll, ensuring provisional tax collection in India.
• Limitation: Since the inclusion is temporary, the income cannot be reported in Form 24Q/Form 16, as it is not considered final income for Indian tax purposes.

Option 2 – Self-Assessment/Advance Tax Payment:

• Alternatively, the employee can be instructed to pay the differential taxes for the US portion of the ESOP income through advance tax or self-assessment.
• In this case, the employee will handle the payment of taxes directly to Indian tax authorities, and the company will not be responsible for collecting these taxes via payroll.
• The employee must ensure that the tax is paid on time and declared in their personal Income Tax Return (ITR).

Treatment of US ESOP Vesting Payments

• US ESOP vesting payments will be made directly by the company to the employee.
• These payments will not be included in the salary for Indian tax computation purposes.
• The amount received will be subject to tax in India, either as capital gains or under other appropriate provisions, depending on the specific structure of the ESOP.

Next Steps and Action Items

• Final Decision: The company will choose between Option 1 (temporary inclusion in payroll) and Option 2 (self-assessment/advance tax payment) based on employee preference or any regulatory considerations.
• Communication to Employee: The employee will be informed of the two options for handling the US portion of ESOP income and will be asked to select their preferred approach.
• Payroll Adjustments: If Option 1 is selected, the payroll team will adjust for the differential taxes related to the US portion of the ESOP income. The US-related income will not be included in the Annual Filing, as there is currently no provision in India’s TDS system to report foreign income and taxes.
• Tax Filing Instructions: If Option 2 is selected, the employee will be reminded to declare the income in their personal ITR and make the necessary differential tax payments.
• Documentation: Ensure that all relevant details, tax implications, and the chosen approach are clearly documented and shared with the employee. This will include instructions for Form 24Q/Form 16 and the reporting of US-related income.

Conclusion

The approach for handling the ESOP income split between India and the US has been outlined in this document. Both options—temporary inclusion in India payroll or self-assessment/advance tax payment—have their advantages. The final decision will be made based on employee preference, regulatory considerations, and the company’s objectives related to tax compliance and employee convenience. The company will proceed with the chosen approach once finalized, ensuring full compliance with tax regulations in both India and the US.