The idea of stock options generates both excitement and envy – depending on whether you are an employee who is a recipient of options or are just an onlooker. Today, stock option plans are becoming an important component of the variable pay of employees in many organisations. This mode of compensation is already an established practice in several global companies and is now becoming a preferred performance reward strategy for Indian companies as well.
For employees, stock options constitute a significant motivational tool that endows them with pride of ownership and results in ultimate wealth creation. However, it is important to note that both employers and employees need to comply with prevailing tax laws. Stock option plans have many variants and tax incidences under Indian tax laws can occur at different stages of a plan. The mechanism of every stock incentive plan is unique and needs to be understood to analyse its taxability.
Prima facie, taxability occurs at two stages: first, when shares are allotted on the exercise date, and later when they are sold.
In the first instance, the difference between the fair market value (FMV) of a share on the exercise date and the exercise price paid by an employee is taxable as salary income. There are specific rules that lay down the detailed methodology to be followed to arrive at the FMV. It is also a common practice for employees of the Indian subsidiaries of global MNCs to be covered under global stock option plans. However, particular care needs to be taken to understand how these foreign plans work, so that their tax implications can be correctly evaluated. Not all plans may result in actual allotment of shares and their taxability may be very different.
Tax implications can be more complex in the case of globally mobile employees who work in different tax jurisdictions during the tenure of a plan. Their taxability depends on their residential status as well as on the period of the services they render in multiple countries. Based on specific facts, each case should be analysed in light of Indian tax laws and the applicable Double Tax Avoidance Treaty.
The second instance of taxation occurs upon the sale of shares allotted to employees pursuant to the exercise mentioned above. Capital gains are computed as laid down in Indian tax laws for shares in general, and the applicable tax rate depends on whether the shares are Indian and listed, and whether the gains are short-term or long-term. However, to compute capital gains from such sales, the cost of the acquisition to be considered is the FMV, on the basis of which the perquisite value was initially computed at the time of allotment upon the exercise.
A new provision, introduced recently in the Act( Income tax Act, 1961), provides for the enhanced notional sale value to be considered to compute capital gains if the FMV (determined in the specified manner) is higher than the actual sale consideration. This creates a fair degree of challenge and complexity for individual shareholders, particularly if the shares are not listed in a recognised stock exchange in India. The taxability of any dividend earned from the resultant shares should not be overlooked, especially in the case of a foreign dividend.
Obligations for employers and employees
It is an individual’s obligation to pay the tax that is due on all income generated from any stock option plan, be it salary income, capital gains or dividend income. While it is the employer’s duty to deduct and deposit tax on salary income, it is the individual’s responsibility to pay tax on taxable dividend income and capital gains by way of advance tax instalments within the mandatory timelines provided in the Act. The employer is responsible for deducting and depositing applicable TDS within monthly due dates. The details of such perquisite income needs to be reported in Form 16 & 12BA issued to the employees.
From a reporting perspective, apart from stating income and/or gains in the respective schedule in the ITR, individuals are also required to make mandatory disclosures of their assets in the asset and liability schedule (Schedule AL) of the ITR, as may be applicable. If foreign shares are held by them, they should take particular care to report this in the foreign assets and income schedule (Schedule FA) of the ITR, failing which penal consequences may follow under the Income-tax Act as well as the ‘Black Money’ law (enacted in 2015).