Corporate Law Newsletter – Cross-Border ESOPs: Regulatory Framework and Compliances
Introduction:
Cross-border Employee Stock Option Plans (ESOPs) have become an essential tool for multinational corporations to attract, retain, and incentivize talent across geographical boundaries. With the increasing globalization of businesses and the rise of multinational enterprises, companies are frequently implementing ESOP schemes that transcend national borders. This newsletter examines two critical scenarios: (i) ESOPs granted by Indian holding companies to employees of their foreign subsidiaries; and (ii) ESOPs granted by foreign holding companies to employees of their Indian subsidiaries.
The regulatory landscape governing cross-border ESOPs involves a complex interplay of corporate law, foreign exchange regulations, taxation provisions, and accounting standards. For private limited companies operating in this space, understanding these compliance requirements is crucial for successful implementation while avoiding legal pitfalls.
Scenario 1: Indian Holding Company Granting ESOPs to Foreign Subsidiary Employees:
When an Indian private limited company grants ESOPs to employees of its foreign subsidiaries, the transaction is primarily governed by the Foreign Exchange Management (Non-Debt Instruments) Rules 2019 and the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 (“FEMA NDI Rules”) and the Companies Act, 2013. Under the current FEMA NDI Rules, Indian companies are permitted to issue ESOPs to employees or directors of their holding companies, joint ventures, or subsidiary companies, whether located in India or abroad.
Further, the Indian company must ensure that the ESOP scheme is structured in accordance with the provisions of Section 62(1)(b) of the Companies Act, 2013, and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014.
From an accounting perspective, the Indian company must recognize the fair value of the ESOPs as an expense over the vesting period in accordance with Indian Accounting Standards (Ind-AS) 102. The expense recognition follows the same principles as domestic ESOPs, with the grant date fair value being amortized over the service period. The company must also consider the impact of foreign exchange fluctuations on the valuation of these options if the exercise price is denominated in foreign currency.
Key FEMA compliance requirements for Indian Companies:
- Form ESOP: Report details of the grant of stock options to non-resident employees. Required to be filed within 30 days from the date of grant1.
- Form FC-GPR: Report allotment of shares upon exercise by non-resident employees within 30 days from the date of allotment. This covers the Foreign Direct Investment (FDI) aspect2.
Scenario 2: Foreign Holding Company Granting ESOPs to Indian Subsidiary Employees:
When a foreign holding company grants ESOPs to employees of its Indian subsidiary, the regulatory landscape becomes significantly more complex. This scenario is governed by the Foreign Exchange Management (Overseas Investment) Rules, 2022, the Foreign Exchange Management (Overseas Investment) Regulations, 2022, and the Foreign Exchange Management (Overseas Investment) Directions, 2022, collectively referred herein as the “ODI Rules”.
Under the OI Rules, a resident individual who is: (i) an employee or a director of an Indian subsidiary or a branch of an overseas entity; or (ii) an Indian entity in which the overseas entity has direct or indirect equity holding, may acquire shares or interests under an Employee Benefit Scheme offered by such overseas entity. A critical requirement is that the ESOPs must be offered by the issuing overseas entity “globally on a uniform basis,” meaning the scheme should be substantially similar across all jurisdictions where the foreign company operates.
The acquisition of shares under foreign ESOPs is classified as either Overseas Portfolio Investment (OPI) if the holding is less than 10% of the equity capital without control, or as Overseas Direct Investment (ODI) if the holding exceeds 10% or confers control. Most ESOP arrangements fall under the OPI category due to the typical size of individual employee holdings.
From a taxation standpoint, Indian employees receiving foreign ESOPs are subject to Indian tax laws on both the perquisite income at the time of exercise and capital gains upon sale of shares. The perquisite value, calculated as the difference between the fair market value on the exercise date and the exercise price, is taxed as salary income. The Indian employer (subsidiary) is required to deduct tax at source (TDS) on this perquisite value and report it in the employee’s Form 16.
Key Compliance Requirements for Foreign Companies and Indian Subsidiaries:
- Pursuant to the ODI Rules, in case of acquisition of shares through the ESOP route, the Indian Subsidiary (whose resident Indian employees have exercised the ESOPs of the US Holding Company) will be required to do the semi-annual reporting with the Reserve Bank of India in Form OPI3.
- The Form OPI is required to be filed with the Reserve Bank of India through the AD Bank within 60 days from the end of half-year (i.e., September / March) in which the overseas investment is made by the resident Indian employees.
- If the investment qualifies as Overseas Direct Investment (ODI) rather than Overseas Portfolio Investment (OPI), the OI Directions require that the resident individual must report the transaction in Form FC. 5
- LRS Scheme: Reserve Bank of India (“RBI”) issued Master direction on the Liberalized Remittance Scheme (“LRS Scheme”) under which the Authorized Dealer Bank allows remittance by resident individual without RBI approval only up to USD 250,000 (United State Dollars Two Hundred and Fifty Thousand) per financial year for any permitted capital or current account transaction or a combination of both (“LRS Limit”). While there is no limit on the amount of remittance for acquisition of shares under ESOP, Para 22(7) of the OI Directions specifies that such remittances shall be reckoned towards the LRS limit of the person concerned.
Key Challenges:
Implementing cross-border ESOP schemes presents several challenges that companies must navigate carefully. The requirement for foreign ESOPs to be offered “globally on a uniform basis” can be difficult to interpret and implement practically, as different jurisdictions may have varying legal and regulatory requirements that necessitate some degree of customization.
Companies should also consider the impact of employee migration, as individuals may change their residence status during the period from grant to exercise, potentially affecting the tax treatment and compliance obligations.
Conclusion:
Cross-border ESOP arrangements represent a powerful tool for talent retention and alignment in today’s global business environment. However, their implementation requires careful navigation of complex regulatory frameworks spanning multiple jurisdictions. For private limited companies, understanding the distinction between the two primary scenarios – Indian companies granting ESOPs to foreign employees and foreign companies granting ESOPs to Indian employees – is crucial for ensuring compliance and maximizing the benefits of these arrangements.
As the global economy becomes increasingly interconnected, cross-border ESOPs will likely become even more prevalent. Companies that invest in understanding and properly implementing these arrangements today will be better positioned to attract and retain top talent in an increasingly competitive global marketplace while maintaining full regulatory compliance across all relevant jurisdictions.
