Employee Stock option plans (ESOPs) is one of the most common and prevailing arrangements between employer and employee wherein shares of the company are offered to the employee at discounted rates or on a free of cost basis. This methodology is mostly opted by the startups to enhance interest of the employee in the company and have funds management as it ensures salary without any cash outflow.
From last one year, the most common area of litigation between industry and the GST authority is applicability of GST on the Employee Stock Option plans allotted by Indian subsidiary companies of the foreign holding company to its employees. As per GST authorities, such transaction is considered as import of service by Indian Subsidiary Company from its foreign holding company and is liable to GST under Reverse Charge Mechanism (RCM).
This article discusses applicability of GST on Employee Stock option plans, whether allotted by Indian Company or foreign company.
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What is Employee Stock option Plans (ESOPs)
- ESOP is an employee compensation plan wherein shares of the company are allotted to the employees of the company at discounted rate or on free of cost basis subject to terms and conditions.
- In general, ESOPs are offered to the employee holding designation above a specified designation and subject to a vesting period. E.g. Employees having designation of manager or above are entitled to the ESOPs.
- Vesting period means a minimum period of employment the employee is required to serve in the company to become entitled to the ESOPs.
- ESOPs is predominantly used for following reasons:
- No Funds outflow: ESOPs are a non-monetary employee compensation mentioned wherein a part of the salary is paid to the employee in form of shares. This method prevails in start-ups as it does not require any cash outflow.
- Employee motivation: Once an employee becomes shareholders of the company they become owners of the company and they work hard to enhance the value of the company and corresponding value of their shares.
- ESOPs can be offered at one go or on a partial basis. E.g. 200 shares will be given to the employee once they complete three years in the company or 50 ESOPs will be given to the employee in the first month of every financial year for next 4 years.
- Lets understand the ESOP with Example,
- Company has offered following ESOPs to the employee:
- 100 shares @Rs.100
- Option/vesting period – 5 years
- Company has offered following ESOPs to the employee:
- This implies that the employee will be entitled to 100 ESOPs at the end of 5 years of employment subject to payment of INR 100 for each share irrespective of market value of the shares.
- In such case, if market value of such share is INR 500 on the date of allotment then employee has simply got the benefit of INR 40,000 {(500-100)*100} through ESOPs
- Such payment in kind of INR 40,000 is considered as salary of the employee.
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Process of Issuance of ESOPs
a. ESOPs issued by Domestic Companies:
- As discussed above, in the case of a domestic company, shares of the domestic company are offered to its employees at a discounted rate or on a free of cost basis.
- Such difference between market value of the share and cost of the share is considered as employee cost and employees are liable to pay income tax on such amount under the head salary.
b. ESOPs issued by Indian Subsidiary company of the foreign holding company
- Modus Operandi:
- Foreign Holding Company: ABC LLC
- Indian Subsidary Company: ABC Private Limited
- Employees of ABC private limited are given the shares of ABC LLC under ESOP scheme.
- Therefore, salary of ABC Private limited is given through allotment of shares of ABC LLC.
- This method is mostly prevailing in IT sectors. Shares of foreign holding company are not listed on Indian stock exchange.
- Foreign Company in turns recovered the value of such ESOPs from the Indian Subsidiary.
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GST Implication on ESOPs
a. ESOPs issued by Domestic Company:
Following is the GST implications on the ESOPs issued by the Domestic company to its employee:
- Under GST, it is a settled position that services provided by an employee to the employer in the course of or in relation to his employment is neither considered as supply of goods nor considered as supply of service.
- Therefore, no GST is applicable on consideration paid for employment.
- E.g.
- Salary Given to Employee (as per employment contract): INR 20,000 p.m.
- Rental amount paid to the employee for using his premises: INR 30,000 p.m.
- In such a case, the salary amount is out of the GST ambit and no GST is payable on the same irrespective of the amount of salary.
- However, the rental amount paid to the employee is not coming out of the employer and employee relationship. Therefore, even though the rent amount is paid to an employee of the company still the same shall be subject to GST, subject to registration of employee under GST (considering threshold limit and other exemptions)
- ESOP are paid to the employee out of employer and employee relationship. Therefore, irrespective of the amount of ESOPs, GST is not applicable on ESOPs offered by the domestic company to its employees.
- However, the employee will be required to pay income tax on the same.
b. ESOPs issued by Indian Subsidiary Companies
- As per ongoing litigations on applicability of GST on ESOPs issued by the Indian subsidiary company of its foreign company, GST authority are alleging that such transaction is considered as import of service by domestic company and therefore GST is applicable on the same.
- As per GST authority, an employment contract exists between the Indian Company and its employees. Therefore, issues of ESOPs by the Indian subsidiary company to the employee are payable under employer and employee relationship and therefore, the same is not liable to GST.
- Since an Indian company is allotting the shares of the foreign holding company and the value of such shares is paid by the Indian Company to the foreign holding company. GST Authority is taking the stand that allotment of shares of the foreign companies are outside the purview of the employment contract and therefore, the same is liable to GST.
- It is pertinent to note that there is no clarification or ruling issued on this matter so far. Following can be the understanding of the legal position:
- Allotment of Securities and payment of salary, both transactions are outside the GST Ambit.
- However, Foreign companies are allowing Indian companies to allot its shares to the Indian company. Therefore, the same may be construed as foreign company taking an obligation on behalf of the Indian Companies, could imply that the holding company is tolerating or consenting to perform an action on behalf of the subsidiary.
- Accordingly, such transaction may come under GST purview in pursuant of Entry No. 5(e) of Schedule II of CGST Law “agreeing to the obligation to refrain from an act, or to tolerate an act or a situation, or to do an act” is considered as supply of services.
- Scope of entry 5(e) is very wide and GST Authorities are triggering the same entry in such cases.
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Further Course of Action
- Since no final judgment or clarification is issued by the GST authorities on this matter. The Companies are required to prepare their agreement post vetting by professionals.
- Any language or clause in agreement may give colour of supply of service to this transaction and may bring the same under GST purview.
- Levy of GST on this transaction will increase the cash outflow for the company on account of GST liability.
Also Read: How to Calculate GST in an Excel Sheet: Step-by-Step Guide
Frequently Asked Questions
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Whether GST is payable on the ESOPs issued by the Company to the Employees?
- In common parlance, ESOPs are issued by the Company to its employees are in pursuance of employment contracts. Any payment made by the employer to the employee under employment contract are outside the GST ambitTherefore, such a transaction is out of the GST Ambit.
- However, litigation is prevailing where shares are allotted of the foreign holding company to the Indian Employees.
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If no GST is payable on ESOPs of the Indian Company, whether the employees are also exempt from payment of Income Tax on such allotment?
- Exemption is provided under GST law only. However, as far as income tax act is concerned, market value of such shares is considered as Income under head salary and Income tax is payable on the same.
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If GST is applicable on allotment of shares of foreign company then whether the employee will be required to pay GST on the same?
- If such a transaction eventually comes under GST, then the Indian Company will be required to pay GST on the same under Reverse Charge Mechanism.
- The employees will not be liable to pay GST in any possible case.
