Taxation of Esops when on a foreign assignment

Stock award is a popular method of rewarding talented and industrious employees. However, employees who render services across different jurisdictions may trigger a taxable presence in two or more jurisdictions. Such employees at times need to deal with the issue of double taxation on such benefits.

A normal stock incentive plan has three phases – grant, vest and exercise. The trigger for taxation in India is allotment of shares to the employee, post exercise. The difference between the fair market value (FMV) on the date of exercise and the grant price is taxed as perquisite.

Taxation may become complicated if the tax laws in the two jurisdictions differ. The employee may need to apply the provisions of the double taxation avoidance agreements (DTAA) while claiming relief from double taxation.

Let’s take the case of Mr A, an Indian employee who is sent on a two-year assignment to the US commencing from January 1, 2012 till December 31, 2013. He was granted stock options by his employer on December 1, 2011 which were vested in January 1, 2014. He has exercised these options in June 2014.

As per the Indian laws, Mr A is liable to pay tax on the stock benefit on allotment i.e. in June 2014. However, since he has been working in the US for a considerable time between the grant and vest of the options, the proportionate benefit would be subject to tax in the US. Thus Mr A is taxed in India and the US on the same income. If Mr A qualifies to be a resident and ordinarily resident in India during the financial year, he would be able to avail foreign tax credit for the US taxes in his Indian income-tax return and await for the refund to be issued by Indian tax authorities.

If he qualifies to be a non-resident in India, then the question arises whether only the benefit proportionate to India services during the period of grant to vest should be subject to tax in India. In the instant case, Mr A has rendered India services only for one month during the period of grant to vest and hence the proportionate benefit relatable to the India service period is only for one month.

Guidance for taxation of the benefit is provided in the OECD Commentary, which provides the taxation principle based on the ‘sourcing rule’. Hence, the right of taxation of the stock benefit is given to the country where the employee has rendered the service.

This principle has also been upheld by the Delhi high court in the case of ACIT vs. Robert Arthur Keltz. In that case, the employee was deputed to India in April 2006. He was granted stock options in 2004 that vested in January 2007 and were exercised in February 2007. For the financial year 2006-07, Robert’s residential status in India was resident but not ordinarily resident (RBNOR). Being RBNOR, he offered to tax the amount of proportionate stock benefit that relates to his Indian assignment during the grant to vest period.

The assessing officer did not accept the contention of the employee and sought to tax the entire stock benefit accruing to the employee, The commissioner of income tax appeals and the tribunal ruled in favour of the employee. The Delhi high court dismissed the appeal filed by the tax department against the order of the tribunal and hence upheld the position of proportionate taxation.

The principle of ‘source-based’ taxation has also been supported by the decisions of the Delhi tribunal in the case of Eric Moroux and Ellias D Rozario. The erstwhile fringe benefit tax circular on employee stock option subjects only as much benefit to tax as relatable to the India period of stay during the grant period (period between grant to vesting of the options) bears to the total grant period.

However, this clarification is missing in the context of the current perquisite tax rules. Hence, the question that remains open is the taxation methodology that should be applied for a ‘resident and ordinarily resident’ in India. While, the ‘source-based’ approach seems to be the most logical, in the absence of clear guidelines, the conservative approach to claim relief from double taxation would be to claim a foreign tax credit.

Considering the significant number of employees that travel on account of assignments, projects and deputations to and from India and the number of employers issuing stock awards to employees, it is advisable that the tax provisions too clearly lay down the methodology of source-based taxation to obviate litigation.