Decoding the Taxation of Foreign ESOPs in India

Why Foreign ESOPs Matter for Indian Employees?

Indian professionals are being hired in large numbers by startups and multinational corporations, particularly in tech hubs like Bangalore and Gurgaon. They provide foreign ESOPs, or stock options in the parent company, to entice talent. As demonstrated by instances such as Flipkart's Walmart exit or Indians at US unicorn IPOs, this can result in significant wealth creation for employees.

The catch is that ESOPs generate ESOP taxation events at several points in time, not just when you sell, in contrast to salary income. Furthermore, disclosure requirements under India's Income Tax Act and even the Black Money (Money Laundering) Act apply to foreign shares.

The 4 Tax Touchpoints Explained

1. Grant – no tax yet

At grant, you receive only a promise. No shares change hands, so there’s no tax in India.

2. Exercise – perquisite tax kicks in

The taxed perquisite under "Salaries" is the difference between the exercise price and the fair market value (FMV) at the time of exercise. TDS is supposed to be deducted by employers.

Example:

• Options granted: 1,000 at ₹100 each
• FMV on exercise: ₹400
• Taxable perquisite = (₹400 – ₹100) × 1,000 = ₹3,00,000

This ₹3,00,000 is added to your taxable salary for the year.

3. Holding – no immediate taxation, but reporting is required

Once exercised, if you hold the shares, no tax applies immediately. But you must disclose them in Schedule FA (Foreign Assets) of your tax return.

If your income is above ₹50 lakh, they also go in Schedule AL (Assets & Liabilities)

Skipping this can trigger penalties under the Black Money Act

4. Sale – capital gains tax

When you sell, the difference between the sale price and FMV at exercise is taxed as capital gains.

• Held <24 months: short-term, taxed at slab rate.
• Held ≥24 months: long-term, taxed at 12.5% plus surcharge and cess

Case study: Raj exercises at ₹100 when FMV is ₹400. Later, he sells at ₹800 after 30 months.

• Perquisite taxed earlier = ₹3,00,000
• Sale price (₹800 × 1,000) – FMV (₹400 × 1,000) = ₹4,00,000 capital gain
• LTCG at 12.5% applies

Domestic vs Foreign ESOPs: The Big Differences

• Valuation: Indian merchant banker reports are the foundation of domestic ESOPs. Third-party valuations or foreign stock exchange prices are used by foreign ESOPs.
• Disclosure: Domestic ESOPs are not required to be reported in Schedule FA, but foreign ESOPs are.
• Currency conversion: The RBI telegraphic transfer buying rates must be used to convert foreign shares to Indian rupees.
• Double taxation: According to India's DTAA treaties, you must submit Form 67 to claim credit in India if tax is withheld overseas (such as through US brokerage withholding).

Other Factors Employees Often Miss

Residential status: Residents of India pay taxes on their worldwide income. RNORs and non-residents have a more limited scope.

Exchange rates: Official RBI rates, not those offered by brokers, must be used to convert FMV and gains.

Documentation: Save tax receipts, broker statements, and FMV certificates. The most common reason for disagreements in ESOP audits is missing documentation.

Penalties: Under the Black Money Act, failing to disclose foreign assets may result in penalties or even legal action.

Strategy: How to Manage Your ESOPs Smartly

Although early exercise locks up cash, it can reduce perquisite tax because FMV may be lower. There may be more tax implications if you exercise later. Still, you will have greater liquidity certainty by holding some of your vested shares for long-term growth and selling some at liquidity events to diversify and pay taxes.

Additionally, if foreign tax was withheld, make sure to file Form 67 before your ITR; otherwise, you forfeit your ability to deduct taxes.

Wrapping Up

Although they bring complicated tax regulations, foreign ESOPs are effective wealth creators. Missing a step can reduce your gains, from perquisite tax at exercise to Schedule FA disclosure and double taxation issues.

Schedule your workouts, maintain your records, and appropriately file your disclosures. When properly implemented, ESOPs can transform paper wealth into actual financial independence.

Frequently Asked Questions (FAQs)