GST Implication on Employee Stock Option Plans (ESOPs)

GST Implication on Employee Stock Option Plans (ESOPs)

Any services provided under Employer and employee arrangement are kept outside the GST ambit as they are neither considered as supply of goods nor supply of services. Employee Stock Option Plans (ESOPs) is also one of the most common methods of payment of employment considerations under which a company issues its shares to the employees at a discounted rate. 

In ongoing GST audits across India, in most of the states, GST Authorities have questioned the taxability of ESOPs allotted by the Indian Subsidiary Companies of its foreign Holding Company to its employees. The GST authority is alleging that such a transaction is considered as import of service by the Indian subsidiary company from foreign company and therefore, is liable to GST under reverse charge mechanism (RCM).

In this article a detailed discussion is carried out about applicability of GST on ESOPs:

1. What is Employee Stock option Plans (ESOPs)

  • ESOP is a type of employee compensation plan in which equity of the company is offered to the employees. These shares are available to the employees at the discounted rate or at free of cost.
  • Employees have to serve a minimum period of time, known as vesting period, to become eligible for ESOPs. They can exercise this option after expiry of the vesting period.
  • This method attached employees to the company by giving them a share of the company’s net worth. This strives employees to work harder toward enhancing the value of the company as it increases their own value of investment.
  • Example,

Say ABC Pvt. Ltd. offers its employees the following ESOP-

  • 100 shares @Rs.100
  • Option/vesting period – 5 years

This implies, after serving employment of 5 years, employees shall have the option to buy 100 shares at Rs.100 each, irrespective of the market value of the company’s stock. 

2. Process of Issuance of ESOPs

  1. ESOPs issued by Domestic Companies:
  1. In case of Domestic Companies, Shares of Domestic companies are offered to the employees at discounted rates or free of cost.
  2. Such an amount of waiver, i.e., difference between market value and offered price is considered as part of employment consideration and employee is liable to pay Income tax on same under the head salary.
  1. ESOPs issued by Indian Subsidiary Company of Foreign companies:
    1. ESOPs is a most popular employee incentive in the Technology Sector wherein shares of foreign entities or parent companies are issued to the employees of Indian Companies at discounted rates or without any consideration.
    2. Employees are enrolled on payroll of Indian Subsidiary. However, shares are issued of the foreign Holding Company.
    3. Foreign Company in turns recovered the value of such ESOPs from the Indian Subsidiary.

3. GST Implication on ESOPs

  1. ESOPs issued by Domestic Company:
    1. GST is levied on supply of goods and services. 
    2. As per Entry No. 1 of Schedule III of CGST Act, 2017, services 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.
    3. Further, As per Section 2(52) of CGST Act, “Goods” means every kind of movable property other than money and securities. As per Section 2(101) of CGST Act, “Services” means anything other than Goods, money and securities.
    4. Therefore, issuance of securities under ESOPs is neither considered as supply of goods nor supply of services. Therefore, same is not liable to GST.
    5. ESOPs are issued in pursuance of employment contract and therefore, same is not liable to GST.
  1. ESOPs issued by Indian Subsidiary Companies
    1. In ongoing GST Audit cases, GST Authority is taking the stand that shares of the foreign companies are allotted to the employees of the Indian Subsidiary. However, foreign holding company is not the employer.
    2. Employment contract exists between employees and Indian Subsidiary Company. Foreign Company is a third party and has nothing to do with employment contract.
    3. The obligation of providing shares under the employment contracts rests with the employer, i.e., Indian Company. 
    4. Therefore, such allotment of shares by the foreign company on behalf of the Indian Subsidiary Company is considered as import of service by Indian Subsidiary from the foreign holding company and the same is liable to GST under Reverse charge mechanism.
    5. Allotment of shares to the employee is a compensation under Employment contract and same is outside the GST purview. 
    6. However, allotment of shares by foreign companies on behalf of Indians is an Import of Financial Services by Indian Subsidiary.

4. Legal Framework of GST on ESOPs issued by Foreign Holding Company

  • Issuances of Shares or securities are neither considered as goods nor services and payment made under employment contract is neither considered as supply of goods nor services.
  • Therefore, allotment of shares to the employees is prima facie not liable to GST.
  • However, other leg of the transaction, i.e., foreign company is 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.
  • As per Entry No. 5(e) of Schedule II of CGST Act, “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 this entry is very wide and GST authorities interpret that service provided by foreign company falls under this entry and therefore, same is liable to GST.
  • However, GST law also provides for the concept of pure agent under Rule 33 of CGST Rules.
  • As per Rule 33 of CGST Rules, the expenditure or costs incurred by a supplier as a pure agent of the recipient of supply shall be excluded from the value of supply subject to the fulfillment of following conditions:
    • the supplier acts as a pure agent of the recipient of the supply, when he makes the payment to the third party on authorisation by such recipient;
    • the payment made by the pure agent on behalf of the recipient of supply has been separately indicated in the invoice issued by the pure agent to the recipient of service; and
    • the supplies procured by the pure agent from the third party as a pure agent of the recipient of supply are in addition to the services he supplies on his own account.
  • Therefore, considering the concept of pure agent, it may be considered that Foreign Holding Company has acted as pure agent of Indian Subsidiary Company and such transaction may come outside the GST ambit.

5. Way ahead

  • Vesting of ESOPs by third parties may take the color of supply of services and may under the purview of GST.
  • ESOP transactions and agreements between foreign Holding Company and Indian Subsidiary Company need to be structured very cautiously as different drafting may lead to different taxable positions.
  • Therefore, it is of utmost important to get these agreements and transactions vet and incorporate the specific clause to protect the interest of both the company and the employee.

DISCLAIMER: The views expressed are strictly of the author and VJM & Associates LLP. The contents of this article are solely for informational purpose. It does not constitute professional advice or recommendation of firm. Neither the author nor firm and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any information in this article nor for any actions taken in reliance thereon.

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