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Taxation of ESOPs from Foreign Companies

Taxation of ESOPs from Foreign Companies

ESOPs from foreign companies are taxed at two stages in India, impacting high-income salaried employees significantly:

  1. On Exercise (Perquisite under Salary):
    • When an employee exercises ESOPs, the difference between the Fair Market Value (FMV) of the shares on the exercise date and the exercise price is treated as a perquisite under Section 17(2)(vi).
    • This amount is added to the employee’s salary income and taxed at the applicable slab rates (30% for income above ₹10 lakh in the old regime or ₹15 lakh in the new regime, plus surcharge and cess).
    • For foreign ESOPs, the FMV is determined as per Rule 3(8) of the Income Tax Rules, typically based on the closing price on the foreign stock exchange where the shares are listed. If unlisted, a valuation by a merchant banker is required.
    • Example: If an employee exercises 1,000 shares at ₹100 each when the FMV is ₹500, the perquisite is (₹500 – ₹100) × 1,000 = ₹4,00,000, taxable as salary income.
  2. On Sale (Capital Gains):
    • When the employee sells the shares, the difference between the sale price and the FMV on the exercise date is treated as capital gains.
    • Holding Period (as per Budget 2024):
      • Listed shares (on recognized foreign exchanges): 12 months for Long-Term Capital Gains (LTCG); otherwise, Short-Term Capital Gains (STCG).
      • Unlisted shares: 24 months for LTCG; otherwise, STCG.
    • Tax Rates:
      • LTCG: 12.5% without indexation on gains above ₹1,25,000 (Section 112A for listed shares).
      • STCG: 15% for listed shares (Section 111A); for unlisted shares, taxed at slab rates (30% for high-income earners).
    • Example: If the employee sells the 1,000 shares at ₹700 each, the capital gain is (₹700 – ₹500) × 1,000 = ₹2,00,000. If held for over 12 months (listed shares), LTCG tax is (₹2,00,000 – ₹1,25,000) × 12.5% = ₹9,375, plus cess.
  3. Foreign Asset Disclosure:
    • Indian residents must disclose foreign ESOP shares in their Income Tax Return (ITR) under Schedule FA (Foreign Assets) in ITR-2 or ITR-3, including details like company name, share count, and value.
    • Budget 2024 has relaxed penalties for non-reporting foreign assets up to ₹20 lakh, benefiting employees with small ESOP holdings.
  4. Double Taxation Relief:
    • If the perquisite or capital gains are taxed in the foreign country (e.g., the US), employees can claim relief under Double Taxation Avoidance Agreements (DTAAs) by filing Form 67. This typically allows a foreign tax credit against Indian tax liability.

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