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Cross-border ESOP Structures

Employee stock options (“ESOPs”) have been used as an effective retention tool globally. Cross-border ESOP structures can be considered by a variety of global businesses with existing Indian presence and by investors that propose to set up greenfield presence or acquire operating businesses in India. Moreover, Indian companies can also issue ESOPs to employees of their foreign holding, subsidiary or joint venture companies. This article discusses various cross-border ESOP structures and identifies key considerations arising under Indian corporate, foreign exchange and taxation laws. 

A. Cross-border Options: Inbound and Outbound

1. Incentive plans by foreign companies for Indian employees

Indian overseas investment rules permit foreign companies to issue stock options under its ESOP schemes to employees or directors of their Indian offices (“Foreign Options”) provided that (i) the Foreign Options are offered globally on a uniform basis; (ii) the Indian office files an annual return with details of exercise of the Foreign Options by Indian employees; and (iii) amounts payable on sale of any shares held pursuant to exercise of Foreign Options by Indian employees are repatriated to India within 90 days. The foreign company may also choose to repurchase the granted or vested Foreign Options and/or shares issued pursuant to exercise of Foreign Options in terms of the ESOP scheme/ offer document and, in such a scenario, an annual return is to be filed by the foreign company’s Indian office, specifying the details of remittance. 

2. Incentive plans by Indian companies to foreign employees

Per the provisions of the Indian foreign direct investment rules (“FDI Policy”), an Indian company can issue ESOPs (“Indian Options”) or sweat equity shares to the employees/directors of its holding company, joint ventures or subsidiaries outside India. Indian companies: (i) may grant the Indian Options under its ESOP scheme, which should comply with the Indian Companies Act, 2013 (“Companies Act”), and applicable limits, related conditions applicable to the foreign direct investment amount under the FDI Policy; and (ii) should file a return with the central bank within 30 days of issuance of the Indian Options. The Indian company will also be required to submit certificates confirming compliance with Indian laws whilst filing this return.

The ESOP/ Indian Options can be issued to employees or directors (whether in India or overseas) of the company or its subsidiary/ holding company. Per the Companies Act, companies (except start-up companies) cannot issue ESOPs to (i) an employee who is a promoter or a person belonging to the promoter group, or (ii) a director who (either himself or through his relative or through anybody corporate, directly or indirectly) holds more than 10% of the outstanding equity shares of the company.

The issuance process as per the Companies Act involves drawing up a suitable plan – ESOP scheme and obtaining board consent and shareholder approval (by way of special resolution). ESOP’s can be issued directly or through an employee welfare or ESOP trust. Also, Indian companies are required to make disclosures relating to total number of stock options to be granted, identification of classes of employees entitled to participate in the ESOP scheme, terms of vesting and exercise, valuation of options and exercise price, the conditions under which the options can lapse, etc. A minimum period of 1 (one) year is prescribed for vesting of ESOPs under the Companies Act and, though options are not transferable, as the shares may be transferable, companies may prescribe a lock-in period for shares issued pursuant to exercise of ESOPs. In case of listed companies, companies must also be mindful of the SEBI (Share Based Employee Benefits) Regulations, 2014, which are substantive.

ESOP schemes should be carefully drawn up in line with this regulatory framework, setting out clear terms of grant, vesting and liquidation of options. The terms of the ESOP scheme often provide for an acceleration of ESOPs pursuant to an acquisition of the company. Consequently, the impact of an acquisition (including whether it would trigger accelerated vesting/ exercise or lapse of the ESOPs) should be assessed and structured by potential investors by reviewing the terms of ESOP scheme.

B. ESOP Structures

1. Vanilla Stock Options

Vanilla ESOPs (in the form of both Indian Options and Foreign Options) can be issued pursuant to ESOP schemes of the Indian or foreign companies and the laws/ conditions set out in paragraph A above. In our view, there is considerable flexibility under these conditions. For options offered by foreign companies to Indian employees, there are no restrictions or monetary limits on the amount that an option holder can remit towards exercise of Foreign Options, and, as above, general permission is available under Indian foreign exchange rules for subscription to Foreign Options. As specified in paragraph A above, issuance of Indian Options is subject to Companies Act and must be within sectoral limits under the FDI Policy. As (i) the procedure under the Companies Act is not too cumbersome, and (ii) sectoral limits for foreign investment in India are not very stringent, and applicable only to sensitive or specific sectors, including broadcasting, print media, multi-brand retailing, such conditionalities will likely not have an impact on most issuances of Indian Options.

2. Cashless ESOPs

Foreign Options can be issued on a cashless basis such that there is no money outflow from India. Whilst Indian foreign exchange regulations do not restrict cashless Foreign Options, structures involving the cashless mechanism should be set out very clearly in the employee stock option plans, to avoid any non-compliance/ breach of foreign exchange laws and contractual arrangements that may be applicable. Interestingly, the Companies Act  does not appear to envisage a cashless issue of Indian Options, basis that: (i) ESOPs are defined to mean such options (given to directors, officers or employees of a company or its holding company or subsidiary company) that entitle the holders to purchase the shares of the company at a future date at a pre-determined price; and (ii) the company is required to state the exercise price and formula used to arrive at such price at the time of issuance of options. However, companies are permitted to provide money/ loans to its employees to purchase shares of the company, subject to the conditions set out in the Companies Act.

3. Restricted Stock Units (RSUs)

RSUs involve transferring units upfront to the employees, with a provision of reverse vesting. In the event an employee quits his employment, the issued units revert to the employers. The Companies Act does not envisage any procedure for issuance of RSUs separately, but states that options issued to employees who resign shall expire or shall be exercised by the employee in terms of the ESOP scheme. Also, this arrangement is not too efficient in light of the Indian taxation laws. As soon as the employees receive shares, including restricted stock unit, it becomes taxable in the hands of the recipient. Additionally, from a foreign exchange control perspective, such reverse vesting with the employers and surrender of stock options are not envisaged.

4. Penny Stocks

A common ESOP structure for foreign companies – penny stocks are not typically in the form of stock options; the shares are given to employees at a penny. In case of Foreign Options, the rules applicable to the overseas company will determine permissibility of such issuance. Indian Options are typically issued pursuant to a valuation exercise under the Companies Act and are subject to disclosures, charge to profit & loss account and limitations (period of vesting, exercise price, etc.), and, therefore, this structure of issuance of stocks at a penny would need to be considered only if it renders other overriding commercial benefits to the issuing company.

5. Sweat Equity

The shares under this structure are issued in consideration of services (whether past or future), given to the company’s employees on favourable terms, in recognition of their work. In case of Indian Options, as per Companies Act, sweat equity shares are equity shares issued by a company to its directors or employees (whether in India or overseas) at a discount or for consideration other than cash, for providing their know-how or making available rights, in the nature of intellectual property rights or value additions, by whatever name called. Issuance of sweat equity is subject to conditions, such as : (i) the issue should not be for more than 15% of the existing paid up equity share capital in a year or shares of the issue value of INR 50,000,000 (~USD 666,666), whichever is higher, (ii) a shareholders’ resolution with two third majority should approve such issue and specify number of shares, current market price, consideration (if any), classes of directors or employees to whom such equity shares are issued, etc., (iii) such sweat equity shares issued to directors or employees shall be locked in/ non-transferable for a minimum period of three years from the date of allotment, etc. From an Indian taxation perspective, this option involves taxation of the entire amount of the shares given, in the hands of the recipient. The FDI Policy permits issuance of sweat equity shares, subject to such scheme being compliant with Indian company laws. Issuance of sweat equity to Indian employees of foreign companies will need to be examined, as, whilst Indian overseas investment regulations permit subscription pursuant to ESOP or cashless ESOP, there is no specific permission for subscription of sweat equity shares.

6. Roll Over Stocks

This option works well in case of acquisitions or mergers. The ESOP holders are given the choice to replace options held by them in the current entity, with options of the merged entity. Alternatively, the acquirer may also set conditions for existing options of the company. This could include cancellation of the existing stock option plan, partially or completely. Indian ESOP holders will typically roll over the consideration received (from cashing out employee stock options of existing company), to the US acquirer entity. Simply put, the money received from the Indian company is invested back into the US acquirer entity. However, drafting of such stock option plan is critical in such cases, as the plan should specifically include roll over provisions and at the same time, be compliant with the Indian company law modalities. It should also explain tax implications on the option holders of such rollover.

In our view, there are a couple of issues surrounding this arrangement:

  • Taxation perspective – Rollover of shares held by employees of Indian companies for shares or options in the foreign company would result in recognition of capital gains if the value of the shares of the foreign company is higher than the cost of acquisition of the shares of the Indian company whose shares are rolled over. If the shares were held for more than 24 months, then the gains would be taxed as long-term capital gains at 20%. Rollover of options would also be treated as two separate transaction for tax purposes. The cashing out of existing options would result in cash payment to the option holder being regarded as bonus and taxed accordingly. Thereafter, the proceeds would be used to pay for the options in the foreign company, if there is an upfront payment for grant of options.
  • In case roll overs are not considered as ESOPs, then the employee’s investment into the US acquirer entity could trigger the liberalised remittance scheme (“LRS”); this needs to be carefully structured as an ESOP. Roll over under LRS should be examined to ensure there is no round tripping of funds.

7. Stock Options Equivalent in LLP Structure

Stock options can be structured by LLPs with performance milestones. Upon satisfaction of a particular milestone, an employee may be proportionately vested with a share in the LLP, in such percentage as may be decided in advance. As the LLP would be an Indian entity, there are no foreign exchange/ legal restrictions on this option – this should ideally be covered in the LLP agreement, to structure the nuances in detail. This flexibility makes this structure a more viable option for global companies. When the option is actually vested (LLP being owned by foreign entities/ individuals), foreign exchange as well as corporate law filings may need to be made. However, the introduction of an employee as a partner in the LLP would need to be carefully done to ensure that there is no tax impact.

8. Consolidation Structure

This structure may find its place in group companies. Employees of subsidiaries could be provided with an option to replace their current stock holdings in the Indian subsidiary by stock options in the foreign holding company. The ratio of holding company vs. subsidiary should be pre-decided. The legal conditionalities will apply as per the ESOP structure chosen – each with its own conditions. If such ESOPs are not being issued pursuant to, and in terms of an ESOP Scheme issued by the foreign company (in which case general permission is available under Indian overseas investment regulations), the requirement to obtain approval of the central bank will have to be assessed.

9. Stock Appreciation Right (SAR)/ Phantom Equity Plan (PEP)

Under SAR/PEP, employees are allotted notional shares/ units at a pre-determined price. Upon fulfilment of employees’ vesting conditions, a cash is paid equivalent to the net gain i.e. appreciation in the price of underlying shares (without involving any cash investment on part of the employee). The use of SAR/PEP will have to be drafted into the employment contract, and whilst Indian laws are silent on the permissibility and conditions applicable for use of SAR/PEP, if used, these shall be subject to principles applicable to Indian Options and Foreign Options discussed in this article.

10. Overall provisions for attracting and retaining employees

In case companies are anticipating/ expecting a strategic investor or a buy-out situation, or even in case of longer vesting periods and/ or change in control events, an option to buy out can be featured as a ‘liquidity event’. Such liquidity events should be drafted in stock option plans with a view to provide benefits of liquidity to current employees. This option binds the promoters and will therefore need to be carefully structured.


ESOPs and the various equity-based incentive structures, as set forth above, are an attractive means to attract, motivate, incentivise and retain employees. In each case, the interests of all stakeholders concerned must be weighed against each type of ESOP structure, before finalising the ESOP structure best suited for the specific needs and commercial objectives of the entity, whether foreign or Indian. The key determinants to choose the ideal structure of ESOPs involve the need to create value for employees, tax efficiency, permissibility under Indian corporate and foreign exchange law, with its administration being the next important consideration. In our experience, vanilla stock options are the most commonly used/ preferred structures in India. It will be important to carefully draft the relevant ESOP scheme, in compliance with applicable laws, whilst structuring feasible ESOP terms and make requisite and timely filings with Indian authorities for use of cross-border ESOPs.