Restricted Stock Units – When, Where and How is it taxable?

Introduction

Restricted Stock Units (RSUs) are performance-based employee benefit by means of stocks granted by the company that entitles the employees to enjoy the shares of the company (or cash equivalent of the shares) on the exercise date, provided that the conditions pertaining to performance and duration of work have been fulfilled over the vesting period. The shares granted under RSUs can be from the direct employer’s company or from the holding company of the direct employer (Here, the shares can be issued either from a company incorporated in India or from a company incorporated abroad).

It should be noted that RSUs do not have an exercise price since the employees are granted shares (or cash equivalent of the shares) directly with restrictions. Whereas, under an Employee Stock Option Plan (ESOP) and an Employee Stock Purchase Plan (ESPP), the employer shall predetermine the exercise price for the award. The exercise price under the ESOP shall be determined as a discounted price based on the fair market value on the exercise date, and the exercise price under the ESPP shall be predetermined on the grant date.

In the article below, we discussed the taxation rules related to RSUs granted for employees.

Important Definitions

1. Grant Date: The date on which the option to exercise the award after the vesting period was given to the employee. (Here, the term “award” refers to the “right to purchase shares or stock options of the company or the right to receive cash equivalent to the shares or stock options value of the company.”) 

2. Vesting Period: The time between the date an award is issued and the date the award will vest if certain conditions are met is referred to as the vesting period. During the vesting period, the employee has no right to the award. Generally, the RSUs vesting period can be single or multiple for a grant, for example 30% each year or as a single vesting period after 3 years.

3. Vesting date: The date on which the employee will be entitled to the benefit of ownership of the award if predetermined conditions are met. The employee shall be eligible to exercise the award allotted under the grant on or after the vesting date.

4. Exercise Price: The predetermined price at which the employee will be eligible to purchase the shares or stock options granted at a later date. The exercise price is the amount that the employees will pay in exchange for the vested shares or stock options. However, there is no exercise price for the RSUs.

5. Exercise period: The time between the date the shares are vested and the date the exercise period expires. The employee has the right to exercise the award allotted on the grant date.

6. Exercise date: The date on which the employee exercises the award. It needs to be noted that the vesting date can be different from the exercise date.

Taxation of Restricted Stock Units in India

RSUs are taxable in two instances in India:

• When shares are allotted to the employee after he has exercised the option on completion of the vesting period,
• When the employee opts to sell the allotted shares under the RSU

1. When shares are allotted to the employee after he has exercised the option on completion of the vesting period:

The difference between the fair market value of the shares as of the exercise date and the amount paid by the employee for the exercise or subscription of the shares is calculated and taxed at the time of allotment of shares on the exercise date. This taxable value is called “perquisite value” and is taxed under the head “Income from Salaries”. Here, since the RSUs do not have an exercise price, the fair market value of the RSUs shall be fully taxable as perquisite. It shall be noted that in the event the employer provides the compensation in the form of cash equivalent to the shares, the value of the perquisite shall be the actual cash received by the employee upon the sale of shares in the open market.

Tax Rates

 For the perquisite value, the taxpayer is taxed according to the income tax slab applicable to the taxpayer for the reporting financial year. The tax component shall either be settled by way of part sale of allotted shares equivalent to the tax calculated on the perquisite value or be deducted from the fixed salary component.

2. When the employee opts to sell the allotted shares under the RSU:

 At the time when an employee sells the shares that were allotted to him under RSU, tax is levied on any amount of profits or gains arising from such a transaction. Such a profit is taxable under the head “Capital Gains.” The tax amount applicable to capital gains shall be directly paid by the employee as “short-term capital gains” and “long-term capital gains” depending upon the period of holding of such shares.

Tax Rates for Long term Capital Gains

For LTCG on the sale of equity shares/units of equity-oriented funds listed on recognised stock exchanges in India, the applicable tax rate is 10% without indexation + (surcharge and health and education cess) over and above Rs. 1 lakh.

Here, the concessional rate of 10% will be applicable if:

1. In the case of a company’s equity share, securities transaction tax (STT) was paid on both the acquisition and transfer of such a capital asset; and
2. In the case of a unit of an equity-oriented fund or a unit of a business trust, STT has been paid on the transfer of such a capital asset.

For LTCG on the sale of unlisted stock, the applicable tax rate is 20% with indexation (+surcharge and health and education cess). The cost inflation index shall be used in order to compute the indexed value of the purchase cost. However, in this case, where the stocks are held by a non-resident Indian, the tax is 10% without indexation.

Here, it shall also be noted that in the event the listed shares were purchased prior to January 31^st, 2018, then the cost of acquisition shall be the higher of the following:

1. Whichever is lower, the fair market value as of January 31st, 2018 or the actual selling price;
2. Actual Purchase Price

If the shares come from a company incorporated in another country, the 10% tax break does not apply. However, if that company is listed under any International Financial Services Centre (IFSC) located in India and if the trading of allotted shares takes place in the said IFSC, then the concessional rate of 10% shall be applied.

However, the Government of India has given the option of claiming exemption from paying this capital gains tax if the taxpayer reinvests the amount in certain specified forms of investment and can thereby save long-term capital gain tax.

Tax Rates for Short term Capital Gains

For STCG, where the securities transaction tax is not applicable, the short-term capital gain is added to your income tax return and the taxpayer is taxed according to his income tax slab.

For STCG, where the securities transaction tax is applicable, the applicable tax rate is 15% + (surcharge and health and education cess).

Tax treatment of RSUs in India

The RSU perquisite is taxable based on the period of stay during the vesting period and resident status at the time of the grant of option. Typically, the country in which the employee served at the time of RSU grant may be different from the country in which the vesting and exercise occur, resulting in a conflict over the apportionment of taxing the perquisite between the countries. The value of perquisites in such cases shall be determined on a pro-rata basis based on the period of stay during the vesting period

Application of Double Tax Avoidance Agreement (DTAA) for RSU taxation

Where an assessee is a resident and an ordinary resident, the global income earned and received should be taxable in India. This would amount to double taxation on the same amount if the income was subject to tax in the other country as well.

However, in this case, he must pay foreign taxes on the income earned abroad in that particular country. In such cases, based on the DTAA between the foreign country and India, he can claim a foreign tax credit for such taxes paid abroad in proportion to the income chargeable to tax in India when filing his income tax returns.

In such a situation, where an employee exercise shares under an RSU, he needs to pay tax on the perquisites in the foreign country (i.e., the country in which the taxable RSU perquisite arises) and claim a foreign tax credit in India against the income chargeable to tax in India.

Foreign tax credit (FTC) is a non-refundable tax credit for income tax payments made to a foreign government as a result of foreign income tax withholdings. The assessee may claim relief for taxes paid on income earned in a foreign country that is also taxed in his or her home country. 

This article has been written by Parkave B an intern with V Ramaratnam and Company, Chartered Accountants. To know more about  Recognised Stock Exchange (RSU) taxation, and ESOP taxation you may reach out to V Ramaratnam and Company, Tax Consultants in Chennai.