Overseas Investment Through ESOP: OPI Under New OI Rules

15 December 2022 • CS Gyanendu Shekhar

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Overseas Investment Through ESOP: OPI Under New OI Rules

15 December 2022 • CS Gyanendu Shekhar

It is a general practice by foreign entities to compensate the employees / directors of their India entity (subsidiary / office) by way of Employee Stock Ownership Plan (ESOP). Prior to August 2022, the employees were permitted to acquire shares under ESOP and there was a reporting requirement of submission of Form ESOP by the Indian company (employer) to the RBI. In the month of August 2022, new rules and regulations were notified which changed the classification of such investments and associated reporting requirements by the Indian entity. Now acquisition of shares through ESOP will be classified as Overseas Portfolio Investment (OPI).

The Government of India issued the Foreign Exchange Management (Overseas Investment) Rules, 2022 (“OI Rules“), Foreign Exchange Management (Overseas Investment) Regulations, 2022 (“ODI Regulations“) and Foreign Exchange Management (Overseas Investment) Directions, 2022 (“ODI Directions“) in the month of August 2022 which brough about certain key amendments related to overseas investment. In this article we shall discuss in detail the amendments to general permissions and further reporting of overseas investments by way acquisition of shares through Employee Stock Ownership Plan (ESOP).

ESOP BY FOREIGN ENTITY TO EMPLOYEES / DIRECTORS OF INDIAN ENTITY / SUBSIDIARY SHALL BE CONSIDERED OVERSEAS PORTFOLIO INVESTMENT (OPI)

Under the new OI Rules, shares acquired by employees and directors of Indian subsidiary / office under an ESOP offered by a foreign entity and such acquisition is less than ten per cent. of the equity capital, whether listed or unlisted, shall be treated as OPI. The Indian entity must comply with the requirements under the new OI Rules and Regulations. Though the acquirer of the such shares is deemed to have made OPI, in this case the burden to comply with the reporting requirements of RBI is on the Indian entity.

For example, if a foreign holding company issues shares through ESOP to its directors / employees of Indian subsidiary, the transaction shall be classified as OPI by the person acquiring the shares but the onus of reporting shall be on the Indian subsidiary.

EARLIER ESOP CONDITIONALITIES

A resident individual was permitted to acquire, without limit, shares or interest under ESOP subject to certain conditionalities. Else, it was necessary to obtain prior approval from the RBI. The exemption from taking RBI approval was dependent on the nature of ESOP and status of the individual acquiring it. These are listed below:

  • The issuing company had a direct or indirect equity holding in the Indian company (employer);
  • The ESOP was offered by the issuing company globally on a uniform basis (e.g., on same general terms as applicable to other subsidiaries of the issuing company);
  • An Authorized Dealer (i.e., bank authorized to deal in foreign currency) was used to convert and transmit the funds to purchase the shares (as applicable); and
  • The Indian employing entity, through its Authorized Dealer Bank, submitted an annual report on Form ESOP to the RBI reporting the details of the outward remittances and participants in the share plans (to be done later).

Additionally, there existed a “cashless exercise” exemption vide FED Master Direction No. 15/2015-16    dated 01st January 2016 (now superseded with the new OI Rules) where employees were permitted to acquire shares under cashless Employees Stock Option Programme (ESOP) issued by a company outside India, provided it does not involve any remittance from India. This exemption was applicable to Restricted Stock Units (RSUs) that do not require any payment from the employees to acquire the shares. The new OI Riles is silent on this aspect of “cashless exercise” of ESOP.

THE NEW OVERSEAS INVESTMENT RULES

The new OI Rules replaces all previously available exemptions to grant ESOPs to Indian residents with the new “general permission”, which requires, inter alia, that half-yearly reports be filed with the Reserve Bank of India (RBI) through an Authorized Dealer (AD) Bank in India.

The New OI Rules also permit a resident individual to acquire, without limit, shares or interest under ESOP or employee benefits scheme or sweat equity shares offered by the overseas entity subject to the following:

  • The resident individual is an employee or a director of an office in India or a branch of an overseas entity or a subsidiary in India of an overseas entity or of an Indian entity in which the overseas entity has direct or indirect equity holding;
  • The issue of ESOP or employee benefits scheme are offered by the issuing overseas entity globally on a uniform basis.

An attempt to understand the missing cashless ESOP

The new OI Rules has removed the cashless exercise of ESOP from general permissions which was previously available in the erstwhile rules. The previous rule contained a specific condition that “an AD was used to convert and transmit the funds to purchase the shares”. Hence, the regulator felt the need to include one specific para on cashless exercise of ESOP where funds were not actually remitted.

Since the new General Permissions do not include the reference related to conversion and transmission of funds for acquisition of ESOP through AD Bank, we can safely conclude that the new permissions are inclusive of all types of ESOP which shall also include the “cashless exercise”.

INTERPLAY WITH LIBERALIZED REMITTANCE SCHEME (LRS)

RBI has also revised the Master Directions on Liberalized Remittance Scheme (LRS) to align with the new OI Rules, ODI Regulations and ODI Directions. Erstwhile LRS  rules , permitted individuals to remit up to USD 250,000 out of India each financial year for certain permitted transactions including acquisition of shares. These transactions included acquisition of qualification shares by directors, acquisition of shares through Right Issue and purchase of shares in joint ventures or wholly owned subsidiaries. However, the previous guidelines had no mention of shares acquired through ESOP. The revised LRS Master Direction now requires that all such acquisition of shares shall be done under new OI Rules (Schedule III, specifying the manner in which investments can be made by resident individuals).

The new OI Rules has clarified that while a resident individual is permitted to acquire foreign shares under ESOP without limit, the value of such shares will count towards such individual’s LRS limit of USD 250,000.

REPORTING REQUIREMENTS

Form and Due dates

Prior to notification of the new OI Rules, such acquisition and holding of shares by way of ESOP was reported through Form ESOP which was filed annually. Under the new OI Rules the Indian company is mandated to now submit half yearly reports in Form OPI to the RBI through its AD Bank. The half-yearly reports due for the periods ending 31 March and 30 September must be submitted within 60 days of the end of such reporting period. This means that for the period ending 30 September, the Form OPI will require to be submitted on or before 29 November.

Periodicity of reporting in Form OPI

Reading the Master Directions on OI, one may opine that the Form OPI is required to be filed on half-yearly basis. Even in the table of LSF (Late Submission Fees) appearing in the Master Directions, Form OPI has been clubbed along with other periodical returns. However, in the Form OPI, the Indian company is required to give a declaration of shares issued / purchased by the foreign company. Here, the question arises if the half yearly return is to be filed when there might be no transaction during any particular half-year?

Recent interaction with the RBI has revealed that this reporting shall be only when there is a transaction to report and it should not be viewed as a periodical return. Hence, if there is any change in holding, i.e. acquisition or disinvestment, then only the Indian company is required to file Form OPI in that particular half-year within the prescribed due dates.

When shall the grant of Restricted Stock Units (RSU) be reported?

The RSU are granted to employees / directors pursuant to a grant agreement and the RSU gets converted to regular share after the vesting period. These units are transferred upfront to the employees/ directors with a provision of “reverse vesting”, i.e. issued units get reverted to the employer (entity issuing such RSUs) in case the employees leave the company before the conversion to regular share.

Since from a FEMA perspective, such reverse vesting with the employers and surrender of stock options are not envisaged, in our opinion, it is better to report such transactions at the time of actual vesting, i.e. conversion to regular stock. The employee / director is not required to remit any funds for acquisition of these RSUs and further conversion to regular share, hence, such transaction can be termed as cashless exercise. The reporting requirement shall be triggered on the date of conversion of the RSU into shares after the expiry of the vesting period, i.e. the date on which employee/director actually holds the shares in the foreign entity.

Though there may not be any cash remittance in grant of RSUs and subsequent conversion to regular stock, it is prudent to file Form OPI through the AD Bank as previous reporting may be required by the regulators prior to receiving the remittance against sale proceeds of such shares. For ease of understanding this transaction, one must agree that overseas investment in any entity is by way of acquisition of shares; it may be with or without consideration.

Some open questions which need further clarity

The newly introduced Form OPI which will be used for reporting investment through ESOP (through part B of the Form), has fields in which net investment / disinvestment at cost basis is to be reported. Since RBI has mentioned in that Form itself that market rate / realisation rate cannot be the cost and it should correspond to the actual amount of investment made, we can assume that the amount being remitted for acquisition of shares will be reported. This interpretation is also aligning with the revised LRS Master directions as the permissible amount of investment will be counted against the overall LRS limit of the individual.

In case the shares are acquired pursuant to a “cashless exercise”, going by the above interpretation the company will be required to report ZERO in these fields where the actual amount of investment/ disinvestment is to be reported. But this cannot be the intent of the regulator to ask the companies to file return in which the amount of overseas investment is ZERO.

In the same Form, the remittance and repatriation values are also required to be reported. Hence, in our opinion, the investment at cost shall be the face value of shares and actual amount of remittance and repatriation can be mentioned in separate columns provided for that purpose. This interpretation confirms that the net investment value will be correctly reported if investment as well as disinvestment will be reported on face value of the shares.

REPATRIATION REQUIREMENTS

The employee / director who is the beneficiary of ESOP shares gets benefitted when these shares are repurchased by the company or they are sold in the open market. Thereafter, the amount of sale proceeds is repatriated to India.

Earlier, the sale proceeds of ESOP shares were required to be repatriated within 90 days such sale. The repatriation requirements have also been modified by the notification of new OI Rules. Now, two timelines have been provided based on the percentage of shareholding. It is the individual’s responsibility to comply with the repatriation requirements. The timelines are listed below:

  • If an individual acquires shares that represent less than 10% of the company’s share capital, the individual will be required to repatriate any proceeds related to the securities within 180 days of receipt of such sale proceeds of the shares. This shall not apply if the amounts are reinvested by the individual in compliance with the ODI Regulations within the 180-day period.
  • If an individual acquires shares that represent 10% or more of the company’s share capital, the individual will be required to repatriate the proceeds within 90 days of receipt of such sale proceeds of the shares.

overseas-investment-esop-opi

CONCLUSION

The new Overseas Investment Rules, Regulations and Directions have brought much clarity in classification of OPI and further reporting requirements. It has also introduced the concept of LSF in OI reporting which shall be applicable for delayed reporting up to 3 years from the due date of reporting. This will certainly reduce the compliance burden, otherwise in the erstwhile regime, the companies had to plead the RBI through compounding application which took considerable amount of time and efforts from filing the petition to getting the contravention compounded.

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5 comments

  1. Would this reporting be required for the ex-employees as well who received RSUs that got vested while in employment but later left the Company and may still be holding the shares on the date of reporting?

    1. Dear Reader,

      In most cases, the shareholder agreement will restrict the employee from selling shares to anyone other than the company, or via events managed by the company. We assume that your company has allotted RSUs to an employee who has now left the company after vesting to stock and he/she is still holding such stock.

      If you will go through Part-B of Form OPI, you can notice that it is a declaration by the company for net ESOP held abroad through its employees. Since your case the employee has left the company after vesting, the company shall not be required the same.

  2. Thanks for bringing some clarity. However, many small overseas companies, particularly, Start-UPs give stock options to its indian consultants, contractors etc. These are not regular employees. When you discuss ESOPs to employees and directors, do you include these consultants etc also ? If not, what is the status of their ESOPs under new rules.

    1. Dear Reader,

      The erstwhile general permissions authorised to issue all type of awards (against cash or cashless) but the consultants and contractors were kept out of the general permissions as they are not the employees / directors of the company. In the new OI Rules also, the general permissions under which ESOPs can be issued, explicitly mentions the requirement of the beneficiary to be an employee or a director of the company.

      Since the Clause 3 (1) of Schedule III of new OI Rules specifically mentions the conditions of being an employee or a director of the company, in our opinion this is not covering the consultants of employees of any third-party contractor wo are not on rolls of the company.

      Regarding your query on the status of grant of ESOPs to consultants, please be informed that the new OI Rules as well as the Master Directions on OI are silent on this.

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