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Taxation of Employee Stock Options

Privileged & Confidential

Presented by Gouri Puri Amarchand & Mangaldas & Suresh A. Shroff & Co.

September 4, 2014

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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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