Tax Implications of Foreign Company ESOPs for Indian Subsidiary Employees

Written By:
Team Qapita
August 31, 2023

Employee Stock Options (ESOPs) have long been a strategic tool for Indian companies, both listed and unlisted, aiming to incentivize and retain employees, both within and outside India. This practice is not new and has been employed for several decades. ESOPs serve as a powerful motivator and retention strategy, especially in the pursuit of corporate expansion. Interestingly, this practice has transcended borders, with foreign companies also showing interest in extending their ESOP schemes to employees of their Indian subsidiaries and holding companies.

Taxation of ESOPs: A Dual-stage Process  

In the context of Indian employees, the taxation of ESOPs is governed by the provisions of the Income Tax Act, 1961. This taxation process unfolds in two stages. Initially, when an employee exercises their ESOPs, converting them into shares, income tax is levied at the individual slab rate. This is classified as perquisite income. Subsequently, when these shares are eventually sold, capital gains tax, whether long-term or short-term, is applicable based on the duration of holding. Remarkably, this taxation framework remains consistent whether the ESOPs are offered by an Indian or foreign company to Indian employees.

Accounting Standards and Cost Cross Charging

The Indian Accounting Standard (Ind-AS) 102, which applies to Indian companies, and the International Financial Reporting Standards (IFRS), applicable to foreign companies, stipulate that any company issuing ESOPs must recognize and amortize the associated costs within its financial records. Additionally, in the case of ESOPs extended to employees of subsidiaries or holding companies, there's an accounting obligation to cross charge these costs. Consequently, foreign ESOP-granting companies, upon providing ESOPs to their Indian subsidiary employees, are required to allocate the relevant expenses.

GST Authority's Scrutiny and Implications  

Recent news articles have highlighted a significant development. Several Indian companies, mainly in the technology sector, have reportedly received inquiries from India's Goods and Services Tax (GST) Authorities. The authorities are particularly interested in instances where foreign holding companies have granted ESOPs or issued shares to their Indian subsidiary employees, with associated costs being cross charged. The crux of the matter is whether the cross charged cost should be treated as the value of imported services. The GST Authorities argue for the imposition of an 18% GST on the value of these "imports" by Indian companies.

Analysing the Landscape: Accounting, Taxation, and Beyond

Given this intricate scenario, a comprehensive analysis has been conducted on various fronts. This includes delving into accounting standards, taxation regulations, and related statutes concerning ESOPs. The objective is to provide insights into this evolving issue.

ESOPs have proven to be a cornerstone of employee motivation and engagement across industries and geographies. As foreign companies seek to extend their ESOP offerings to Indian subsidiary employees, it's essential to navigate the complex landscape of taxation and accounting regulations. The current scrutiny by GST Authorities adds a layer of complexity, raising pertinent questions about the interpretation of cross charged costs and their classification as imported services.

Understanding GST Implications on Cross-Border ESOPs for Indian Subsidiary Employees  

In the realm of international business, the implementation of Employee Stock Options (ESOPs) by foreign holding companies to reward their Indian subsidiary employees has triggered a new layer of complexity: the question of GST liability. This article delves into the analysis of this matter and offers insights into the potential implications.

GST regulations outline that 'import of service' refers to a foreign entity supplying services to an Indian recipient. This becomes chargeable if specific conditions are met:

a) There must be a service supplier outside India.

b) An Indian recipient of the service must be present.

c) The place of supply should be within India.

d) The recipient must be liable to pay the tax under reverse charge.  

GST Authority's Standpoint

The GST Authority's argument is rooted in the idea that the overseas company, responsible for allotting shares, isn't recognized as an employer. Instead, the Indian subsidiary, the employer of the employees benefiting from the ESOPs, holds the obligation. Thus, the ESOP cost or the value of the benefit, reimbursed by the Indian subsidiary as per accounting standards, is treated as an imported service. Consequently, an 18% GST liability is imposed.

An essential aspect to consider is the lack of a service provider and recipient in this scenario. The very essence of GST's chargeability conditions raises doubts about its applicability in these cases.

ESOPs, by their nature, pertain to employment rather than the rendering of services. The income or gain arising from ESOP exercise is taxed under prevailing income tax provisions. Indian employers must also perform Tax Deduction at Source (TDS). The distinction between "employment" and "service" in tax statutes is apparent, with mutually exclusive provisions for each.

The cost borne by Indian subsidiaries, termed "employee cost," is linked to the employees' contribution. As these employees undertake tasks strictly related to employment, without rendering additional services, the need for GST registration doesn't arise. GST does not apply to ordinary employment-related functions.

The cross charge of costs between holding and subsidiary companies, as per Ind-AS accounting standards, isn't deemed a supply. It's a mere accounting practice that falls outside the scope of GST.

ESOPs: Securities, Goods, or Services

ESOPs qualify as "securities" under the Securities Contracts (Regulation) Act, 1956. In the context of the Central GST Act 2017, these securities do not classify as goods or services. This blurs the line between supply of goods or services, leading to doubts about the imposition of GST.

Considering the absence of fundamental prerequisites for GST charge and its overall chargeability, it appears that imposing GST on Indian subsidiaries of foreign ESOP-issuing companies might not be sustainable.

While this matter remains under scrutiny, it's essential for businesses to remain updated about developments and anticipate potential changes in the tax landscape. The forthcoming decision from the GST Council meeting could have substantial implications. We commit to closely monitoring the situation and providing updates. Should you have any queries or insights about this issue, please don't hesitate to get in touch. Your understanding of this evolving scenario is crucial for informed decision-making.

Team Qapita

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