This post analyses the permissibility of and key legal considerations for share-based benefits/ incentives, like ESOPs, RSUs, SARs, etc., that foreign companies offer to the employees of their Indian group companies.

Introduction

Companies have started using share-linked and share-based benefits as incentives to retain employees on a long-term basis, and it is beginning to be the most valuable component of employees’ compensation/ remuneration or CTC. Employee stock options (“ESOPs”) are among the most common forms of share-based benefits. An ESOP is essentially an option (and not an obligation) granted to employees to acquire shares of the company upon exercising their vested ESOPs. Foreign companies and multi-national corporations have been steadily opening offices, branches and subsidiaries in India (specifically in the form of global capability centres, centres of excellence and innovation centres). While it is desirable in itself to work for these global companies, many of them are also interested in offering ESOPs and other share-based incentives to the employees of the parent foreign company as an added incentive.

The employees of the Indian subsidiary could be ‘Indian residents’ and ‘non-residents’. An individual normally qualifies as an ‘Indian resident’ in any previous year, if he is present in India for a period of 182 (one hundred and eighty two) days or more.[1] Note that for the purpose of this post, we have only analysed the legal considerations under India’s foreign exchange regime vis-à-vis the grant of share-based employee benefits to Indian resident employees.

Assessing permissibility of foreign companies granting share-based employee benefits to their Indian resident employees

Given that the grant of ESOPs by a foreign company to India resident employees of its Indian subsidiary entails the issuances of foreign securities and is therefore a capital account transaction, it is subject to Foreign Exchange Management Act, 1999 (“FEMA”) and Reserve Bank of India (“RBI”) regulations. The key regulatory framework governing overseas investments (including issuance of ESOPs by a foreign company) to a person resident in India is contained in Foreign Exchange Management (Overseas Investment Rules), 2022 (“OI Rules”), Foreign Exchange Management (Overseas Investment) Regulations, 2022 (“OI Regulations”) and the Foreign Exchange Management (Overseas Investment) Directions, 2022 (“OI Directions”) issued by the RBI on August 22, 2022, as amended from time to time.

The OI Rules expressly provide that “A resident individual, who is an employee or a director of an office in India or branch of an overseas entity or a subsidiary in India of an overseas entity or of an Indian entity in which the overseas entity has direct or indirect equity holding, may acquire, without limit, shares or interest under Employee Stock Ownership Plan or Employee Benefits Scheme or sweat equity shares offered by such overseas entity, provided that the issue of Employee Stock Ownership Plan or Employee Benefits Scheme are offered by the issuing overseas entity globally on a uniform basis”.[2]

It should be noted here that while the OI Rules regulate inter alia any ESOP scheme or ‘employee benefits scheme’, the Companies Act, 2013 (“Act”) only expressly recognises and regulates an ‘employee stock option scheme’.[3] An ‘employee benefit scheme’ under the OI Rules has been defined as “any compensation or incentive given to the directors or employees of any entity which gives such directors or employees ownership interest in an overseas entity through ESOP or any similar scheme”.[4] The scope of an ‘employee benefit scheme’ as regulated under the OI Rules is broader than under the Act. Hence, it is not just limited to ESOPs but also extends to schemes such as (i) restricted stock unit schemes (RSUs), (ii) employee stock purchase schemes (ESPS); (iii) stock appreciation rights schemes (SARs); (iv) phantom stock schemes, (v) general employee benefits schemes (GEBS); (vi) retirement benefit schemes (RBS); etc. These schemes provide various structuring options to companies to choose which share-based benefits would better suit their commercial requirements.

Consequently, under any employee benefit scheme that a foreign company adopts, an Indian resident employee or director would be eligible to acquire shares of a foreign company provided the foreign entity issuing the shares offer them globally on a uniform basis. It is pertinent to note that unlike under Indian laws[5], the terms ‘employee’ and ‘director’ are not defined under the OI Rules and so long as the company can demonstrate that the grantee(s) are persons who qualify these positions in their respective company, it can grant share-based benefits to them. Compared to Indian companies who need to abide by the rules under the Act, which has a specific set of requirements – only permanent employees (not including advisors, consultants, promoters and members of the promoter group) can be granted ESOPs, a minimum 1 (one) year vesting requirement (cliff period), board and shareholder approvals, etc.,­ – grants from foreign companies are not subject to such terms. Consequently, foreign companies enjoy a lot of leeway with structuring their share-based employee benefit schemes.

Key compliance and reporting requirements with regard to remittances for acquiring shares of the foreign company upon exercise of the share-based benefits

From a compliance perspective it first needs to be determined whether the transaction would qualify as an ‘overseas direct investment’ (“ODI”) or an ‘overseas portfolio investment’ (“OPI”). The OI Rules define ODI as: (a) acquisition of any unlisted equity capital or subscription as a part of the memorandum of association of a foreign entity, or (b) investment in 10 percent or more of the paid-up equity capital of a listed foreign entity, or (c) investment with control where investment is less than 10ten percent of the paid-up equity capital of a listed foreign entity. OPI on the other hand means any overseas investment which is not ODI.

• For ODI/ OPI – as per the OI Directions, authorised dealer banks (“AD Banks”) may allow remittance by resident Individuals towards overseas investment (ODI and OPI) up to the permissible limits after receiving a duly filled Form FC together with Form A-2, in the event the employees need to remit any amount as the ‘exercise’ / ‘strike’ or ‘purchase’ price.

• For OPI – the reporting is required to be done by the subsidiary in India of an overseas entity; or the Indian entity in which the overseas entity has direct or indirect equity holding where the resident individual is an employee or director; or by the office in India or branch of an overseas entity. Additionally, given that Indian entities are required to file Form OPI on a half-yearly basis providing details of the overseas investment, they would be required disclose any ESOPs or other similar share-based benefit that the Indian resident employees have exercised during the half-year in which such acquisition of shares or interest is made as of September 30th or March 31st.

• Caps on remittance for overseas investments – the RBI had issued a Master Direction on the Liberalised Remittance Scheme (“LRS Scheme”), under which AD Banks may freely allow remittances by resident individuals, without RBI approval, up to USD 250,000 (Two Hundred and Fifty Thousand) per financial year (April to March) for any permitted capital or current account transaction or a combination of both (“LRS Limit”), which can be utilised towards inter alia acquisition of foreign securities, education, family expenses aboard, etc. However, Indian residents are permitted to remit funds towards ESOPs and other similar share-based benefits beyond the LRS Limit, and that any remittance by them would first extinguish their LRS Limit. While any remittance made towards ESOPs would first be reckoned for the individual LRS Limit calculation, it would not be limited to/ by the LRS Limit.

It is pertinent to note that the duty for compliance with regards to an overseas investment is not just on the company but also on the Indian resident employees. However, from a practical standpoint, most companies that offer such share-based benefits to their Indian resident employees would also need to put in place systems and processes to assist the latter with their compliance obligations under applicable laws. This is also important given that it is extremely important to choose the right AD Banks to remit the funds for acquiring shares of the foreign company.

Another crucial aspect that needs to be factored in when structuring the ‘employee benefit schemes’ is the tax consequences and the tax related compliances. This is because the Indian resident employees would qualify as ‘tax residents’ and consequently, the gain they make from the share-based incentives would be subject to tax in India and the Indian company may also be subject to withholding taxes on such incentives, and therefore setting up the right process upfront would be valuable.

Conclusion

Share-based benefits are a tool for workforce hiring and retention and their growing significance is making many companies experiment with different structures. This is augmented by the fact that the law is enabling such experimentation by recognising various types of share-based incentives above and beyond the vanilla ESOP schemes. Foreign companies offering share-based employee benefits have a much lower regulatory threshold than for Indian companies. For instance- (i) there is no minimum 1 year vesting period for the share-based benefits to be exercisable in the hands of the employees; and (ii) the scope of ‘who’ can be offered share-based benefits by a foreign company is broader than by an Indian company. Under the Indian legal framework, only those persons are eligible to receive share-based benefits who qualify as ‘employees’ under the law while for foreign companies there is no such stipulation and hence, in effect, any person who is designated as an employee or director would de facto be eligible for the grant of share-based benefits by a foreign company. Given that the regulatory framework is more favourable towards foreign companies granting share-based benefits, this also serves as a means to incentivise multi-national companies to adopt structures where they offer share-based benefits linked to the foreign company as opposed to their Indian company. This is particularly logical if there are no plans to take the Indian company public (through an IPO) or sell the Indian company, as then there would be no market for the shares of such an Indian company and the employees’ ability to cash in on such shares would be limited, as opposed to the foreign companies’ shares that may already be listed on a foreign stock exchange or provide for other ways through which they can liquidate their shares.

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[1] From a FEMA perspective an Indian resident individual is defined under Rule 2(u) of the OI Rules as “a person resident in India who is a natural person”. Further from a taxation perspective Section 2(42) of the Income-tax Act, 1961 (“IT Act”) defines a ‘resident’ as “a person who is resident in India within the meaning of section 6”. Section 6(1) of the IT Act states that “An individual is said to be resident in India in any previous year, if he— (a) is in India in that year for a period or periods amounting in all to one hundred and eighty-two days or more” or “(c) having within the four years preceding that year been in India for a period or periods amounting in all to three hundred and sixty-five days or more, is in India for a period or periods amounting in all to sixty days or more in that year. …”.

[2] Schedule III, paragraph 3(1) of the OI Rules.

[3] Section 62(1)(b) of the Act. Further ‘employee stock option’ has been defined under Section 2(37) of the Act as “the option given to the directors, officers or employees of a company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price”.

[4] Schedule III, paragraph 3(1) of the OI Rules.

[5] Under the applicable laws in India the term ‘employee’ has comprehensively been defined thereby restricting the persons to whom share-based benefits can be granted by Indian companies.