Restricted Stock Units (RSU): Vesting, Taxability and Reporting in India

Restricted Stock Units (RSU): Vesting, Taxability and Reporting in India

24 December 2022 • CS Gyanendu Shekhar

Overview

Restricted Stock Units (RSU) are a form of equity compensation given to the employees / directors of the company in lieu of any cash bonus. This is given free of cost by the company but with some restrictions. The grant of RSU is “restricted” because it is subject to a vesting schedule, which is generally based on length of employment but in some cases, it is additionally linked to performance too. It may also be also be governed by other limitations such as transfers or sales that your company may impose by way of RSU grant Agreement. Many MNCs in India grant RSU of their holding company to compensate their employees / directors in order to retain the employees in the company for a longer period.

How RSU is different from ESOP?

Unlike ESOP, vesting of which is subject to an option exercised by the employee / director at a future date, RSU are granted upfront to the employees / directors with an option of “reverse vesting” (see next para). After the vesting period is over, the RSU are converted to normal stock (equity) and the holder is vested with the voting rights and rights to receive dividends on these shares. Even if the value of shares falls drastically, they still have some value for the holder as the RSU were allotted free of cost, unlike the shares under ESOP.

What is Reverse Vesting?

The RSU are granted upfront to the employees / directors but they are subject to a vesting schedule, that may be a “graded vesting” schedule or a “cliff” vesting schedule. If the receiver of the RSU leaves the company prior to the expiry of vesting period, these RSU (not yet vested) are vested back in favour of the company and hence this transaction is called reverse vesting. For your ease of understanding the two types of vesting schedules are explained below: –

• Graded Vesting. As the name suggests, the vesting is graded over a period of time, ie. the vesting of a fixed / predetermined percentage of shares happens at regular interval of time. For example, if your company has granted you 1000 RSU with a graded vesting schedule of 25% each year over a period of four years, you will get 25% of your RSU converted to shares on the expiry of one year, 50% of the allotted RSU after the expiry of second year and so on. Once, each portion of the RSU get converted to shares you are eligible to sell those shares.
• Cliff Vesting. This type of vesting is used when the company desires that the employees shall be retained for a longer period of time. Taking the example quoted above while explaining the graded vesting, you will get all of the 1000 RSU allotted to you converted to regular shares after the expiry of four years, i.e. 100% of the shares are vested after the expiry of the vesting period mentioned in the RSU grant Agreement.

Taxability of Restricted Stock Units (RSU)

The RSU can be taxed after clubbing with the salary as a perquisite and thereafter in Capital gains arising on account of holding such shares. You might be interested to know how the tax is deducted and at what rates if the RSU are vested in a foreign country and sold in a foreign country. To make this understanding clear, we have tried to cover each event one by one in the following pointers: –

• Grant of RSU. No tax liability as it is just a promise by the employer to get the shares at a future date subject to fulfilment of certain conditions as may be prescribed by the grant agreement.
• Vesting day (conversion of RSU to shares). As per the vesting schedule a given percentage is transferred to the employee’s account (which may be maintained by some broking house) and the employee gets the right to vote or receive dividend (can be classified as the owner of shares). Now the employee is liable to pay tax on this which is explained below: –
  • The fair market value of the vested shares as on the vesting date is clubbed with the salary of the employee under section 17(2) of the Income Tax Act, 1961 and tax is payable as per the income tax slab rate applicable to the employee. For calculation of the value of perquisite, the exchange rate of the foreign currency prevailing on that particular date is also taken into account.
  • The tax is paid either upfront in cash by the employee or through same day sale of the shares and paying a portion of the sale proceeds as tax. But the most common and default option available to the Indian employees is “sell to cover.”
  • In “sell to cover” method, a portion of the vested shares are sold to meet the tax liability and remaining shares are credited to employee’s account. If you are in 30% tax bracket and you have received 1000 shares, 300 shares will sold to meet the tax liability and remaining 700 will be credited to your account. It means you are holding only 700 shares. Please note that we have ignored the Cess amount here for ease of calculation.
  • At the time of filing ITR, you should declare the holding of foreign shares in schedule FA. While declaring the number of shares, care must be taken that you actually hold 700 shares only as 300 shares were automatically sold to meet the tax liability.
  • Capital Gains. This tax is triggered on account of sale of holdings (explained below). If you have earned some capital gain on account of holding these shares, it must be reported in schedule CG of ITR and you will be liable to capital gain tax as per applicable rates. Since the foreign shares are not listed on Indian stock exchanges, it will be classified as unlisted asset, irrespective of the fact whether they are listed in foreign country or not.
  • Here, the security transaction tax is not paid but the short term and long-term capital gains depending on the period of holding shall be appliable. When sold within 24 months of acquisition, it will be classified as short-term capital asset and will be taxed at the tax rate applicable for your income bracket. When sold after 24 months, it will be classified as long-term capital asset and will be taxed at 20% with indexation benefits. Here, it may please be noted that unlike the listed shares where there is an option to pay 10% tax without indexation, shares received post conversion of RSU will be taxed at 20% (with indexation benefits)only; Income Tax Act, 1961 treats this transaction as a sale of immovable property.
  • If you receive any dividend on these shares, you shall declare it in Schedule OS of ITR.

Is there any double taxation after conversion of RSU to shares?

We often encounter general queries, such as, if there is any double taxation post conversion of RSU to regular shares. This doubt is backed by following transactions: –

• A percentage of your shares corresponding to your tax liability were already sold to meet the tax liability.
• Even if you actually received 700 shares, the value of 1000 shares was clubbed to your salary as perquisites and the same is appearing in your Form 16 under section 17(2). The same value corresponding to 1000 shares is being reflected in Form 12BA under stock options.

The shortest answer to this query is NO. These transactions related to RSU are not taxed twice. If they would have been taxed twice, you might have received a document from the foreign tax regulator which would be akin to the Form 16 depicting the amount of tax deducted. This is because, your company has already taken care of such issues and filed necessary declarations to avoid double taxation (in countries having DTAA agreement).

When the stocks were vested, ie. the RSU were converted to regular shares, the “sell to cover” option was used to meet the tax liability and the value of such shares sold (in your case as quoted above, it shall be corresponding to 300 shares) is shown as TDS by your company and the same is reflected in Form 16 Part B.

Capital Gains on RSU

As stated above, the shares (after conversion from RSU) of MNCs are not listed on Indian Stock Exchanges and hence it will be treated as unlisted securities and accordingly capital gain on short term asset or long-term asset depending on the period of holding shall apply. If the RSU were subject to “cliff vesting” and you sold the shares on the vesting date, no capital gain shall be applicable as the shares were vested and sold on the same date. In graded vesting, capital gains may accrue as most of the employees prefer to sell the shares after the expiry of full vesting period or in some cases even the company restricts to sell any shares unless all the RSU get converted to shares after the expiry of vesting period.

Reporting Requirements

Grant of RSU by the foreign company to the employees / directors of its subsidiary / office will be classified as Overseas Portfolio Investment (OPI) by the individual and this shall be reported in Form OPI Part B to the RBI. We have covered this aspect in detail in our blog on Overseas Investment Through ESOP.

Conclusion

In this article we tried to cover all aspects related to grant of RSU; how it helps in retaining employees, how it gives potential to participate in the employer’s success and get rewarded on account of increase in share prices, your tax liability and related reporting.

After grant of RSU, the Indian company transfers funds equal to the market value of the shares to its foreign holding company. It would also be interesting to explore whether such transactions will be counted against capital account transactions or revenue account transactions under section 37 (1) of the Income Tax Act, 1961. Whether it will be booked as employee benefit expense or capital account loss; there are so many contradicting case laws on this. To know about RSU related transactions in the hands of the employer, we recommend you to keep visiting this space as we will shortly publish our next research article on this.

You may also like to read: –

• • Overseas Investment Through ESOP: OPI Under New OI Rules
  • A Brief on Employee Stock Options Plan (ESOP) in India by a Private Limited Company
  • ESOP: Deferred Tax Payments for Eligible Start-Ups as per Finance Act, 2020