Since last year, during the GST audit, most GST Authorities have questioned the taxability of ESOPs issued by the Indian Subsidiary company to the employees of its foreign holding company. GST Authorities were content that such a transaction is considered an Import of service, and therefore, domestic Indian companies are liable to pay GST on the same under RCM.

In this context, as per recommendations issued by the GST Council, CBIC has issued the clarification on the taxability of shares issued by the Foreign holding company to the employees of the Indian subsidiary company vide Circular No. 213/07/2024-GST dated 26th June 2024.

Analysis of clarification issued by the CBIC is as follows:

1. Brief Facts of the case:

• As per the representations received, some Indian companies provide their employees with the option of transferring the securities/shares of their foreign holding company.
• Such securities are allotted as a part of the compensation package as per the employment contract.
• In such cases, shares of the foreign holding company are allotted directly by the holding company to the concerned employees of the Indian subsidiary company. Post transfer, the cost of such securities is reimbursed by the subsidiary company to the holding company. 

2. Issue under Consideration:

• The issue is raised of taxability of such transaction under GST, i.e., whether issuance of shares by the foreign holding company directly to the employees of the Indian subsidiary company and subsequent reimbursement of such cost by the Indian company to the foreign company can be considered as import of financial services by the Indian subsidiary company.
• Accordingly, GST should be levied on the same in the hands of Indian subsidiary companies under the Reverse Charge mechanism.

3. Types of transfer of securities to the employees

As per the clarification issued by the GST Authority:

• Option of transfer of securities is provided to incentivize the employees and the same is commonly referred to as:
  • Employee Stock Purchase Plan (ESPP);
  • Employee Stock Option Plan (ESOP);
  • Restricted Stock Unit (RSU). 

• Such specific terminology usage depends on the terms of allotment between the employer and the employee.
• ESPPs and ESOPs are typically presented as ‘options’ granted to employees.
• RSUs are a form of awards or rewards contingent upon the employee meeting specific performance standards. 
• However, irrespective of the terminology used, the fundamental essence of the transaction remains the same.

4. Modus Operandi of transfer of shares:

The Modus operandi of the transfer of shares is as follows:

• The domestic subsidiary company gives the option/ facility of ESOP/ESPP/RSU to its employees as a part of the employment contract,
• The employees exercise their stock options, either by purchasing shares at the grant price or by holding the options until they vest.
• The foreign holding company issues shares to the employees and such shares are listed on the foreign stock exchange. The foreign holding company transfers the shares directly to the employees of the subsidiary company.
• Later on, the domestic subsidiary company generally reimburses the cost of such shares to the foreign holding company on a cost-to-cost basis.
• Such reimbursement may be done either through an actual remittance or through an equity transfer.

5. Taxability of such transaction under GST

5.1 Securities are not considered “Goods” or “Services”

• Under GST Law, Securities are considered neither as goods nor as services in terms of the definition of “goods” and “services” given under Section 2 of the CGST Act.
• Securities include ‘shares’ as per the Securities Contracts (Regulation) Act, 1956.
• Therefore, the purchase or sale of securities/shares, in itself, is neither a supply of goods nor a supply of services. 
• Accordingly, in the absence of supply of goods ‘goods’ or ‘services’, GST is not leviable on said transaction of sale/purchase/transfer of securities/shares.

5.2 Employment contracts are outside the GST purview

• The ESOP/ESPP/RSU is a part of the remuneration of the employee by the employer as per the terms of employment. 
• As per Entry 1 of Schedule III of the CGST Act, the services by an employee to the employer in the course of or concerning his employment are treated neither as the supply of goods nor as the supply of services. 
• Therefore, GST is not leviable on the compensation paid to the employee by the employer even in the form of transfer of shares of foreign holding company.

5.3 No GST is payable under RCM by the Indian subsidiary company

• Reimbursement of such securities/ shares is generally done by domestic subsidiary companies on a cost-to-cost basis i.e. equal to the market value of securities without any additional fee, markup, or commission.
• Since the reimbursement is done for the transfer of shares, which is neither classified as goods nor services, the same cannot be treated as import of services by the domestic subsidiary company.
• Accordingly, such transfer is not liable to GST under the CGST Act. 

5.4 GST Implication in case of commission or additional fees

• However, if the foreign holding company charges any additional fee, markup, or commission from the domestic subsidiary company for issuing such shares then the same shall be considered as consideration for the supply of services of arranging the transaction by the foreign holding company to the domestic subsidiary company. 
• In such a case, GST will be leviable on such an amount of the additional fee, markup, or commission.
• Such GST shall be paid by the domestic holding company on a reverse charge basis on such import of services.

6. Conclusion

Taxability of ESOPs has been an area of litigation from last year and Industry has been served with multiple GST notices asking Indian subsidiary companies to pay GST on such transactions under RCM. 

CBIC has clarified the following taxability position:

1. No supply of services is taking place between the foreign holding company and the domestic subsidiary company till reimbursement is done by the Indian subsidiary company on a cost-to-cost basis. 
2. However, in cases where an additional amount is paid, GST would be leviable on such additional amount charged as consideration for the supply of services of facilitating the transaction. Such GST shall be paid by the domestic subsidiary company on a reverse charge basis.

Such Clarification has brought relief for the industry from unnecessary GST notices and litigations.