An individual can acquire foreign shares under an employer share plan or by direct purchase using the liberalised remittance scheme.
By Divya Baweja, Deepika Mathur, and Charmy Parekh
The COVID-19 pandemic has reduced business-linked overseas travel and assignments to a minimum as both employers and employees wait for normalcy to return. What remains steady is the trend towards rewarding employees with foreign shares as compensation structures become increasingly linked to the global performance of large corporations.
An individual can acquire foreign shares under an employer share plan or by direct purchase using the liberalised remittance scheme which allows an individual to acquire foreign shares or while working in an overseas country.
In such a scenario, individuals should be fully aware of the tax incidence and obligations through compensation and encashment lifecycle.
Taxability of shares acquired by employees under an employee share plan:
Taxation of employee share plans happens at 2 stages – first on the allotment of shares (as salary income) and second on the sale of shares (as capital gains). The various stages and taxability are explained below:
i. Grant stage: Typically, no income tax is payable at the grant stage as no shares are allotted to an employee on the grant date. Typically, taxability at grant will arise only if shares are allotted on the date of grant.
ii. Vesting / Exercise: Income tax liability arises when shares are delivered or allotted to employees. The difference between the Fair Market Value (FMV) of shares on the date of allotment and any amount recovered from employees will be taxable as perquisite under the head ‘Income from Salaries’. The FMV for foreign shares needs to be determined by a Category I Merchant banker. The employer is liable to deduct tax on the perquisite value.
An individual who qualifies as a Resident and Ordinarily Resident (ROR) is taxable on worldwide income. On allotment of foreign shares acquired under an employee share plan, the entire perquisite value (including FMV of foreign shares allotted, less consideration paid) is taxable in India as salary. In case the employee qualifies as Resident but not Ordinarily Resident (RNOR) or Non Resident (NR), relying on judicial rulings, only the proportionate gain pertaining to the period of employment in India between the grant to vest period is taxable as salary perquisite.
iii. Sale stage: Post allotment, employee tax liability arises again at the time of sale of shares. Capital gains/ (loss) represented by the difference between the sale price and FMV which has been considered for determining the perquisite value, are taxable. The obligation to deposit tax on capital gains, rests with the employee – to be deposited as advance tax or self-assessment tax. The manner in which capital gains is taxable is explained further below.
In certain cases, employers sell part of the employee shareholding overseas to cover the perquisite tax liability arising in India (commonly known as sell to cover). This could lead to a capital gain or loss depending upon the differential between the actual sales consideration and the FMV considered for salary taxation. It is important for individuals to consider the same for tax purposes.
Tax treatment on sale of shares and dividend income, acquired under an Employee share plan or acquired directly by an individual (non-employee)
When foreign shares are sold, capital gains from the sale of shares will be taxable in India for ROR individuals on the difference between sales consideration and the cost of acquisition and expenses. Cost of acquisition in case of shares acquired under an employee share plan is the FMV on which perquisite tax in India has been paid in India. Cost of acquisition in case of individuals acquiring the shares directly, is the actual purchase price paid by the individual.
Capital gains on shares sold post 24 months of holding would be considered as long-term capital gain and will be taxed at 20% (plus applicable surcharge and cess) after indexation of cost. Long term capital gains on sale of foreign shares can be exempt up to the specified limits, if investment of the same is made in a specified asset in India within a specified time limit. Capital gains on shares held for less than 24 months will be considered as short-term capital gains taxable at the applicable slab rates without any indexation benefit.
As a general rule, in case of RNOR and NR individuals, capital gains are not taxable in case of foreign shares registered outside India and where the sale proceeds are received outside India.
However, in case of indirect transfer of shares, the law states that in case of a capital asset being shares in a company incorporated outside India, it shall be deemed to be situated in India if the shares derive, directly or indirectly, their value substantially from the assets located in India. This would need to be analysed before arriving at any conclusion.
Dividends earned on foreign shares either in cash or as dividend reinvestment is also taxable in India for a ROR at the tax rate applicable to the individual. Tax liability on sale of shares and dividend income needs to be computed by the individual after considering tax treaty benefits, if any.
Reporting obligation in India tax return
In addition to reporting salary income, capital gains income on sale of shares and dividend income in the tax return, foreign shares with various details are required to be reported in the Foreign Asset Reporting schedule and also the Asset and Liability schedule. This is applicable only for ROR cases.
As compensation structures globalise and Indians diversify their asset holdings to include foreign shares, it is imperative for individuals to understand which transactions are taxable, the timing of the tax liability, the computation of tax payable and associated reporting requirements. Non-compliance with any of these obligations can result in stringent penalties under the Income Tax Act
(About the authors: Divya Baweja is Partner, Deloitte India; Deepika Mathur is Director and Charmy Parekh is Deputy Manager with Deloitte Haskins and Sells LLP. )