Understanding Compliance When Receiving Equity Grants as an Employee

Equity grants are a valuable tool for attracting and retaining top talent, offering employees a stake in the company’s future. However, receiving equity-based compensation comes with regulatory obligations that can impact financial planning, tax liabilities, and compliance requirements. As a founder, understanding these complexities is crucial to ensuring that your employees benefit from their equity while avoiding legal and financial complications.

For Indian employees working for a US-domiciled company, the compliance landscape becomes even more intricate. Cross-border equity awards are subject to both Indian and US regulations, covering taxation, foreign exchange controls, and reporting obligations. Your employees may need to navigate dual-tax jurisdictions, while you must ensure that grants are structured in compliance with local laws to prevent unintended tax consequences.

Understanding these obligations early can help you structure equity grants effectively and mitigate risks associated with regulatory missteps. This blog covers different employee-level compliances that you must be aware of when allocating equity grants to your employees.

What are equity grants and why compliance matters?

Equity grants are a common way to compensate employees by giving them a stake in the company’s success. Instead of offering direct cash payments, you allocate a portion of your company’s ownership through structured plans. This approach helps attract top talent, incentivizes long-term commitment, and aligns employees' interests with business growth. 

Equity grants can take different forms, each with distinct financial and regulatory implications. 

• Employee Stock Option Plans (ESOPs): Stock options give employees the right to purchase company shares at a pre-determined price after a vesting period. In the US, Nonqualified Stock Options (NSOs) and Incentive Stock Options (ISOs) are common, while in India, Employee Stock Option Plans (ESOPs) are prevalent. Taxation differs between countries, with India taxing at exercise and sale.
• Restricted Stock Units (RSUs): They represent a promise to deliver shares or cash equivalent upon meeting vesting conditions. RSUs are taxed as ordinary income when vesting in the US, while in India, taxation occurs at vesting and sale.
• Employee Stock Purchase Plans (ESPPs): ESPPs allow employees to purchase company stock at a discounted price through payroll deductions. US ESPPs often offer a 15% discount and may include a ‘lookback’ provision. For Indian employees, foreign exchange considerations under FEMA regulations apply. Taxation depends on plan qualification in both countries.
• Stock Appreciation Rights (SARs): They provide the right to receive the appreciation in stock value over a specified period, usually settled in cash or shares. SARs are useful when actual share transfer is challenging due to regulatory constraints. SARs are typically taxed as ordinary income upon exercise in both US and India.
• Restricted Stock Awards (RSAs): RSAs involve granting actual shares subject to vesting conditions, with full stockholder rights from the grant date. In the US, recipients can file an 83(b) election for potential tax benefits. For Indian employees, RSAs may have implications under FEMA regulations and require RBI approval in some cases.
• Performance Stock Units (PSUs): PSUs are similar to RSUs but with additional performance-based vesting conditions tied to company or individual metrics. They are common in executive compensation packages. Taxation generally occurs upon vesting, based on the number of shares actually earned. 
• Phantom Stocks: They provide financial benefits tied to stock performance without actual share ownership. Phantom stocks are useful for private companies or when share transfer is restricted. Typically settled in cash, phantom stocks simplify cross-border transactions and are taxed as ordinary income upon payout in both countries.

Ensuring compliance with tax laws and regulatory frameworks helps prevent legal risks and unexpected tax liabilities for employees. Since your company operates under US jurisdiction while hiring employees in India, you must address cross-border regulatory requirements. Proper documentation, tax withholding, and foreign exchange compliance are critical to smooth equity grant execution.

What compliance rules should employees know about equity grants?

Here are the key compliance rules related to equity grants that you, as well as your employees must know about: 

Legal adherence

As of August 2022, equity grants are typically classified as Overseas Portfolio Investments (OPI) under the Indian Overseas Investment Regulations. However, the classification can shift to Overseas Direct Investment (ODI) if the equity grant results in ownership of 10% or more of the foreign entity’s paid-up equity capital.

RBI Approval Requirements

• If the overseas parent company holds at least a 51% stake in the Indian entity, no specific Reserve Bank of India (RBI) approval is required for equity grants.
• If the holding is less than 51%, RBI approval is necessary to proceed with the equity grant.

Remittance Rules

When remittance is required to exercise the price of equity options, it is crucial to involve authorized dealer (AD) banks. The process includes filing Form FC along with Form A-2 to facilitate the remittance.

The equity grants must be offered on a globally uniform basis, ensuring fairness across your international workforce.

Financial reporting

Companies granting equity to Indian employees must adhere to specific financial reporting requirements:

• Semi-Annual Reports: Submit Form OPI to the Reserve Bank of India (RBI) through an Authorized Dealer Bank twice a year.
• Reporting Deadlines: Reports are due within 60 days after March 31 and September 30 each year.
• Form ESOPs: Companies must file Form ESOPs in addition to Form OPI when exercising stock options.
• Disclosure Requirements: Reports must disclose any ESOPs or similar share-based benefits exercised by Indian resident employees during the half-year period ending September 30 or March 31.
• Timing of Form ESOPs: This form is submitted when employees exercise their stock options, not just at the semi-annual reporting intervals.

The company granting equity is responsible for the timely and accurate submission of all required forms and reports related to grants, vesting, and exercise.

Repatriation rules

Here are important guidelines for Indian employees on transferring funds related to foreign equity grants:

• Repatriation Timelines: Employees acquiring less than 10% of the company’s share capital must repatriate proceeds within 180 days of receipt. Those with 10% or more ownership have a 90-day window for repatriation.
• Liberalized Remittance Scheme (LRS): Under LRS, Indian residents can remit up to USD 250,000 per financial year for various purposes, including overseas investments. This limit applies to the total of all foreign exchange transactions, including equity-related remittances.
• Tax Collected at Source (TCS): A 5% TCS applies on remittances exceeding Rs. 7,00,000 in a financial year. From October 1, 2023, the TCS rate increased to 20% for remittances exceeding Rs. 7 lakhs, except for education and medical purposes.
• Taxation of Gains: Profits from overseas investments held for more than 24 months are taxed at 20% as long-term capital gains. Shorter holding periods are taxed at applicable income tax slab rates.

Failure to file required forms or meet regulatory standards can result in fines and legal complications. For instance, late filings incur a fee of approximately ₹7,500 per return.

 Understanding the grant letter and associated terms

The grant letter serves as the foundation of an employee’s equity compensation. It outlines the terms and conditions governing their stock options, making it critical for them to review each detail carefully. Overlooking key clauses can result in financial losses, tax inefficiencies, or forfeiture of equity.

• Vesting schedule: This determines when employees gain actual ownership of their equity. A typical schedule might span four years with a one-year cliff, meaning no equity vests until after the first year of employment.
• Exercise price: For stock options, this is the predetermined price at which employees can purchase company shares. It is usually set at the Fair Market Value (FMV) of the stock when the options are granted.

• For US Employees (409A Valuation): Companies typically use a 409A valuation to set the exercise price for US-based employees. This independent appraisal determines the FMV of common stock, ensuring compliance with IRS regulations and avoiding tax penalties.
• For Indian Employees: Indian companies have more flexibility in setting the exercise price. While it is often based on FMV, it can be set at a lower value, subject to regulatory guidelines. This approach allows for potentially more favorable terms for Indian employees while still adhering to local tax and securities laws.

• Expiration dates: Stock options have a limited lifespan. Employees need to be aware of when their options expire to avoid losing the opportunity to exercise them.
• Restrictions: These may include transfer restrictions, lock-up periods, or specific conditions that must be met before exercising options or selling shares.
• Fair Market Value: When Indian subsidiaries receive ESOPs from US parent companies, two valuation reports are required at the time of exercise:
  
  • 409A Valuation (US): An independent appraisal determining the Fair Market Value (FMV) of common stock, ensuring compliance with IRS regulations.
  • Local Merchant Banker Valuation (India): A similar valuation conducted by an Indian merchant banker, adhering to local regulatory requirements.

These dual valuations ensure compliance with both US and Indian tax laws, impacting taxation at various stages of the equity lifecycle. 

Maintaining accurate records of equity transactions

Under the new Indian Overseas Investment Regulations, your company must submit semi-annual reports on Form OPI to the Reserve Bank of India (RBI). These reports include details of shares issued and funds remitted, making employee records essential for compliance.

India-based employees should track details such as:

• Grant details: Employees should maintain records of their grant letters, including the date of the grant, the number of shares or options, and all associated terms.
• Exercise information: For stock options, they must keep detailed records of when options were exercised, how many shares were acquired, and at what price.
• Vesting milestones: Employees must document each vesting event, including the date and number of shares vested.
• Sale transactions: They should record any sale of shares, including the date, number of shares sold, and the sale price.
• Tax-related documents: Every individual must maintain copies of all tax forms related to equity compensation, such as Form 16 for Indian employees. 

Maintaining these records simplifies compliance with both Indian and US tax authorities. It also helps employees reconcile differences in tax treatments, such as capital gains tax in India versus income tax implications in the US.

Meeting reporting and disclosure requirements

Employees receiving equity grants must adhere to stringent reporting obligations in both India and the United States. 

In India:

• Schedule FA (Foreign Assets): Residents must disclose all foreign assets, including equity grants from US-domiciled companies, in their Indian income tax returns. This includes details such as the nature of the asset, its value, and any income derived from it.
• Schedule FSI (Foreign Source Income): Any income from foreign sources, including gains from equity grants, must be reported in this schedule.
• Form 67: This form is used to claim foreign tax credit under the Double Taxation Avoidance Agreement (DTAA) between India and the US.
• Tax Residency Certificate (TRC): Along with Form 67, employees should obtain and submit a TRC. This certificate validates their tax residency status and is essential for availing DTAA benefits and proper tax treatment of equity grants.

The consequences of non-compliance can be severe. In India, failure to disclose foreign assets can result in penalties of up to ₹10 lakhs ($12,000 approximately) per instance.

Taxation compliance for employees receiving equity grants

Since your employees may be subject to taxes in both jurisdictions, understanding these obligations is crucial for accurate tax filings and financial planning.

Tax liabilities in India

Taxation of equity grants occurs at multiple stages:

• At grant: Generally, no tax is applicable in India when stock options are granted. However, employees should check whether their equity structure includes any upfront tax liabilities.
• At vesting: In India, RSUs and certain stock grants are taxed as salary income at the time of vesting, based on FMV of the shares. 
• At exercise: When employees exercise stock options, the difference between the exercise price and FMV is treated as perquisite income in India and subject to taxation.
• At sale: Any profit made when selling shares is subject to capital gains tax. In India, tax rates depend on the holding period: 
  
  • Short-Term Capital Gains (STCG) for shares sold within 24 months 
  • Long-Term Capital Gains (LTCG) for shares held beyond that period. 

Filing income tax returns and declaring equity income

Equity-based income must be reported in annual tax returns in India to ensure compliance with local tax regulations. Employees need to include their stock-related earnings under salary income, perquisites, or capital gains, depending on how their equity was structured.

For US-domiciled companies, employees must also report foreign stock holdings and income. This involves disclosing details of stock grants, vested shares, and capital gains while filing Indian tax returns. Employees earning income from foreign stocks must also complete Form 67 to claim foreign tax credit benefits under DTAA.

To ensure accuracy in tax filings:

• Keep a record of grant dates, vesting schedules, and exercise transactions.
• Report perquisite and capital gains income in the correct tax categories.
• Consult with a tax expert to understand cross-border tax implications and ensure compliance.

Utilizing tax relief options and Double Taxation Avoidance Agreements (DTAA)

The India-US DTAA allows employees to claim relief from double taxation on their stock-based income. Employees paying tax on their equity earnings in the US can offset this liability against Indian taxes by claiming a Foreign Tax Credit (FTC). This ensures they do not pay tax twice on the same income.

To benefit from DTAA provisions:

• Employees must submit Form 67 before filing their Indian tax returns.
• Tax records and proof of foreign tax payments must be maintained to support the FTC claim.
• It is advisable to consult a tax professional to ensure compliance with DTAA regulations.

Taxation Considerations for Mobile Indian Employees Receiving Equity Grants from US Companies

Mobile Indian employees receiving equity grants face unique tax challenges. Key considerations include:

• Dual Taxation: Based on work location during the vesting period, income may be taxable in both India and the US. The India-US DTAA provides relief to prevent double taxation.
• Income Allocation: Equity income is typically allocated based on workdays in each country during vesting. Maintain detailed work location records for accurate tax liability determination.
• Tax Residency Impact: Indian tax residency status affects equity award taxation. NRIs may have different obligations compared to resident Indians.
• Compliance Requirements: File Form 67 in India to claim foreign tax credits. Report foreign assets, including vested equity grants, in the Indian Income Tax Return using Schedule FA.
• Currency Conversion: Use prescribed foreign exchange rates to convert USD values to INR for tax reporting.

Understanding legal compliance for cross-border equity grants

Employees receiving stock options, RSUs, or other forms of equity from a US-domiciled company must adhere to regulations that govern foreign exchange, securities transactions, and cross-border holdings.

Adhering to FEMA (Foreign Exchange Management Act) Regulations

FEMA regulations play a crucial role in governing cross-border equity transactions. Recent amendments have streamlined the process:

• Foreign Currency Accounts (FCAs): Indian exporters can now maintain FCAs with overseas banks for all export transactions. This allows your Indian employees to receive equity-related payments more efficiently.
• Repatriation timeline: Funds received in FCAs must be repatriated to India within one month, after adjusting for forward commitments. Ensure your equity grant structure aligns with this requirement.
• Special Non-Resident Rupee (SNRR) Accounts: Non-residents can now open SNRR accounts with authorized dealer banks in India or their overseas branches. This facilitates smoother transactions for your US-based entity.
• Permissible transactions: SNRR accounts can be used for all permissible current and capital account transactions, including equity-related transfers.
• Account tenure: The seven-year cap on SNRR account tenure has been removed, allowing for long-term equity arrangements.

Ensuring compliance with SEBI (Securities and Exchange Board of India)

SEBI oversees securities transactions in India, impacting how your employees handle their equity grants:

• Reporting requirements: Your Indian employees must report their foreign equity holdings in their annual tax returns using Form 67 and Schedule FA.
• Disclosure norms: Employees acquiring a significant percentage of shares may need to make additional disclosures under SEBI's Substantial Acquisition of Shares and Takeovers Regulations.
• Insider trading regulations: Educate your employees about SEBI's insider trading norms, as they apply to equity holders regardless of their location.
• ESOP guidelines: If you are offering ESOPs, ensure they comply with SEBI's ESOP guidelines, even for a foreign-domiciled company.

Avoid common compliance errors with equity grants

As a founder, ensuring employees avoid common compliance errors helps them maximize their equity benefits while protecting your company from regulatory risks.

Failing to report foreign assets

Many employees receiving equity from a US-domiciled company do not realize they must report these holdings in India. The Income Tax Department requires them to disclose foreign equity under Schedule FA (Foreign Assets) when filing their tax returns. Employees who fail to report their holdings correctly may face tax audits, fines, or scrutiny under India’s Black Money Act, which penalizes undisclosed foreign assets. 

Missing tax deadlines

Employees often miscalculate tax liabilities or miss deadlines when reporting stock-related income. In India, RSUs and exercised stock options are taxed at the time of vesting or sale. Any delay in paying advance tax can result in interest penalties. If employees sell shares and fail to report capital gains within the tax year, they may face additional scrutiny. 

Not understanding grant terms

Misinterpreting equity grant terms can lead to missed opportunities or financial losses. Employees who do not review their vesting schedules risk losing unvested shares if they leave the company early. Those unaware of their exercise windows might let stock options expire. If employees do not account for tax withholding obligations, they may not set aside funds for tax payments, leading to financial strain. 

To prevent compliance errors, encourage your employees to:

• Review their grant agreements carefully and seek professional advice if needed.
• Maintain detailed records of grant dates, exercise transactions, and stock sales.
• Report foreign assets and equity income accurately to tax authorities in India and the US.
• Plan for tax payments by understanding advance tax obligations on vested equity.
• Stay updated on regulatory changes that may impact their equity grants.

Conclusion

Compliance is crucial for employees receiving equity grants, as it directly affects their tax obligations and legal standing. By adhering to reporting requirements, understanding tax liabilities, and maintaining accurate records, employees can maximize the benefits of their equity compensation while avoiding potential legal and financial pitfalls.

At Qapita, we specialize in simplifying equity management and ensuring compliance for startups like yours. Our equity management platform, rated as #1 by G2, streamlines cap table management, automates equity award processes, and provides comprehensive support for regulatory adherence. 

We help you navigate the complex landscape of equity management, ensuring that your employees understand and appreciate the value of their equity grants while you maintain full compliance with regulatory requirements.

Book a 1:1 personalized demo with our experts to learn more about our solutions.

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