Meaning & Taxation of RSUs, ESOPs and ESPPs

Many companies these days are using RSUs, ESOPs and ESPPs to reward as well as retain employees these days. In this blog post I will explain what RSUs, ESOPs and ESPPs are as well as the taxation aspects of them.

Definition of RSU, ESOP and ESPP

1. RSU

RSU stands for Restricted Stock Units. These are basically shares of the company which are given to you free of cost, but with some restrictions. The restrictions are that although the shares will be transferred to you and will be in your “demat” account, you will not be able to sell them till a predetermined future date.

The date on which the shares are transferred to you is called the grant date and the date on which the shares are unlocked for sale is called the vesting date.

Typically, RSUs vest in the ratio 34%/33%/33%. That means if 100 RSUs are granted to you on 1 January 2010, then 34 RSUs (34%) will vest on 1 January 2011 and 33 each (33%) on 1 January 2012 and 2013 respectively. If you leave the company on 1 December 2011, then you will be able to sell only 34 shares and the remaining 66 shares will go back to the company. If you stick around for another month, then you will be able to sell 67 shares (34 + 33) as another 33 shares will vest on 1 January 2012.

Therefore, this is a good mechanism for companies to retain key employees, as employees will lose the ownership of unvested stocks if they leave before the vesting date (although they can still sell the stocks that have already vested).

2. ESOP

ESOP stands for Employee Stock Option Plan. ESOPs are similar to RSUs conceptually, however there are some differences. With ESOPs, an employee does not get shares but instead gets an option to buy shares at a predetermined price on a future date (similar to RSUs).

Like RSUs, ESOPs are given to employees on a particular date, called the grant date. Like RSUs, the ESOPs become usable at a later date, called the vesting date, and can be utilised to buy shares at any future date, called the exercise date. And like RSUs, the vesting ratio for ESOPs is also usually 34%/33%/33%, with 34% vesting a year from the grant date and 33% each two and three years from the grant date. Note however that the price at which the ESOPs can be bought on vesting (called the exercise price) is fixed at the time of granting the ESOPs itself and has no relation with the price on the day of vesting.

So, say, an employee gets 100 ESOPs with an exercise price of $10 upon vesting. That means, the employee has an option to buy 100 shares at a fixed price of $10 per share on the vesting date, irrespective of the market price on that date. On the day of vesting, the share price may either be higher than $10 or lower, depending on how the company is performing. Hence, for the employee, it makes sense to buy the share only if the share price is reasonably higher than $10, since only then can he/she sell it at a profit. If the share price is lower than $10, then buying it will make no sense since the employee will still need to pay $10 per share (as determined on the grant date) even though the current price is lower.

Due to this uncertainty associated with ESOPs, many employees ask for RSUs instead of ESOPs, since with RSUs there is no question of incurring a loss on sale of shares, since the shares are given for free.

3. ESPP

ESPP stands for Employee Stock Purchase Program. Here, the employee can opt to contribute part of his/her salary (typically upto 10-15%) to purchase company shares at a fixed discount to the market price (typically 85% of the market value, i.e. a 15% discount). The purchase typically takes place twice a year, once each in a six month period determined by the company, and the discount is given on the lowest traded price in that six month period.

For example, let’s say that the six month periods are 1 January – 30 June and 1 July – 31 December. And let’s say that the employee opts to invest 10% of his/her monthly salary in the ESPP program. In that case, 10% of the employee’s monthly salary will be deducted from their take-home salary each month and kept separately.

So let’s say that the employee’s monthly salary is $1000. In that case, $100 will be deducted each month, which means in every six month period, $600 will be invested in company stocks. Now let’s assume that in the January 1 – June 30 period, the lowest traded share price at any point of time was $10. Therefore, the employee will be eligible to buy the shares at a discount of 15%, i.e. at $8.5 per share. The amount of of $600 collected will be used to finance this purchase and the employee will get (600 / 8.5) = ~70 shares. Even if the employee chose to sell these shares immediately on purchase, they would earn 70 x $10 = $700, which would be a profit of $100 over the purchase cost. The same process of purchase is repeated again in the next six month period, i.e. July 1 – December 31.



ESPP is a good way to earn money by selling company shares bought at a discount. However, if you are planning to retain the purchased shares and sell at a future date, then it makes sense only if the share value is appreciating in the long run.

Income earned from, and tax treatment of, RSUs, ESOPs and ESPPs

RSUs, ESOPs and ESPPs are different means of purchasing shares. Both purchase and sale of these have tax implications as shown below:

1. On vesting, exercise or purchase:

On vesting of RSUs, exercise of ESOPs and purchase of ESPPs, an income equivalent to the difference between the acquisition price and actual price of the shares is deemed to be perquisite income earned by you.

  • For RSUs, the acquisition price is zero (since RSUs are given for free) and so the entire market value of vested shares is treated as income.
  • For ESOPs, the income is the difference between exercise price and market price on the exercise date.
  • For ESPPs, the income is the difference between the discounted price and market price on the purchase date.

2. On earning dividend income:

Dividend income earned from foreign shares must be declared in column “Dividend income” in Schedule OS of ITR-2 or ITR-4.

3. On sale:

On sale of the shares, the profit earned is a capital gain, and is therefore taxable as such.

  • For RSUs, the difference between the vesting price and the sale price qualifies as capital gains.
  • For ESOPs, the difference between the market price (not exercise price) at the time of exercise and the sale price qualifies as capital gains.
  • For ESPPs, the difference between the market price (not discounted price) at the time of purchase and the sale price qualifies as capital gains.

Depending on the time duration between the acquisition date and the sale date, the profit can either qualify for short-term or long-term capital gains tax.

  • For RSUs, the acquisition date is the vesting date and not the grant date.
  • For ESOPs, the acquisition date is the exercise date and not the grant or vesting date.
  • For ESPPs, the acquisition date is the purchase date.

Moreover, depending on whether the shares are of a listed or unlisted company, the tax liability is different. Listed shares are those that are listed on Indian stock exchanges, such as TCS, HDFC Bank, etc. Unlisted shares are those that are not listed on Indian exchanges, regardless of whether they are of Indian companies or foreign companies listed on foreign exchanges such as Google, Microsoft, Apple, etc.

The short-term and long-term capital gains taxation for listed and unlisted shares is as follows:

Type of sharesPeriod for attracting LTCGTax on STCGTax on LTCG
Listed shares1 year15%0% (tax free)
Unlisted shares (Indian companies)3 yearsAdded to taxable income20% with indexation
Unlisted shares (foreign companies)3 yearsAdded to taxable income20% with indexation

Declaration of RSU, ESOP and ESPP income earned and tax paid in your IT Return

1. RSUs:

– On grant: When RSUs are granted, no income is deemed earned because nothing can be sold yet, and therefore no tax is deducted. However, if the RSUs are of a foreign company, then you must declare them in column “B: Details of Financial Interest in any Entity held” in Schedule FA of ITR-2 or ITR-4 (see below image).

Schedule FA

– On vesting: When RSUs, the market value of the shares vested (number of shares vested x current share price) is added to your taxable income as perquisites. This will be declared in your Form 12BA for the year (given along with Form 16).

Since there is an income deemed to be earned by you, there will also be a corresponding tax due to you (apart from the tax deducted on your salary). The broking site where the RSUs are held (typically Etrade in case of foreign shares) will give three options to pay this additional tax due:

a) Sell-to-cover: This is the default option where 33% of the vested shares are sold immediately and the amount is paid to the government as tax. As a result no additional tax is needed to be deducted from your salary income. The remaining 67% of the vested shares remain in your account and you can sell them at a future date when the share price is higher.

b) Same day sale: Here all the vested RSUs are sold immediately. 33% of the sale proceeds are deducted and paid as tax to the government and the rest to you as income from the sale. No shares are left over after this.



c) Cash exercise: Here no shares are sold by the broker. Instead, the company will deduct an additional tax from your salary to account for this extra income, and the same will be part of your total tax deducted for the year and shown in your Form 16. All vested shares will remain in your account as is.

With same-day sale option, you lose out on future share price gains since all shares are sold immediately. With cash exercise, there is a risk because you pay tax from your pocket based on the market value at the time of grant, but if the share value tanks significantly by the time you sell it, then you may potentially not even recover the amount paid as tax! Sell-to-cover is therefore the default option and also the safest one, because the tax is settled without you having to pay anything, while the remaining shares remain in your account to be sold at a future date.

For foreign shares, if the foreign country where the shares are listed has a Double Taxation Avoidance Agreement (DTAA) with India, then the tax generated from selling the shares abroad will be transferred to the Indian government by the host country.

However, for the tax collected by selling foreign shares to be transferred automatically to the Indian government, you will likely need to submit a country-specific declaration to the foreign broker that you are not a resident of that country (in case of US shares, the respective form is W8-BEN). If this declaration is not submitted, the tax deducted abroad will not be reflected in your Form 16 and you may need to pay the same tax again from your pocket, resulting in double taxation.

– On sale: Based on the time duration between vesting and sale, either short-term or long-term capital gain will apply. This capital gain must be declared in Schedule CG of ITR-2 or ITR-4 so that tax may be suitably charged.

2. ESOPs:

– On grant: No income is deemed earned and no tax is due, similar to RSUs. For foreign ESOPs however, the same must be declared in column “B: Details of Financial Interest in any Entity held” in Schedule FA of ITR-2 or ITR-4 (see above image).

– On vesting: No income is deemed earned and no tax is due, since these are stock options of and not actual stocks.

– On exercise: When the stock options are exercised and stocks purchased, the difference between the exercise value and market price of the shares is deemed to be “income earned” and is shown as perquisite income in Form 12BA. Like for RSUs, this also implies that a corresponding additional tax is deductible from your salary for this extra income. And like RSUs, this tax liability can be met either as a deduction from your salary income (TDS) or by selling some or all of the shares purchased.

Again, for foreign shares, if there is DTAA with the host country, then the tax generated from selling the shares abroad will be transferred to the Indian government.

– On sale: Based on the time duration between exercise and sale, either short-term or long-term capital gain will apply. This capital gain must be declared in Schedule CG of ITR-2 or ITR-4 so that tax may be suitably charged.

3. ESPPs:

– On purchase: The difference between the discounted share price and market price of the shares is deemed to be “income earned” and is shown as perquisite income in Form 12BA. Again, like for RSUs and ESOPs, this implies a corresponding tax liability and the same is deducted as TDS by your company from your salary income. For foreign shares, the same must be declared in column “B: Details of Financial Interest in any Entity held” in Schedule FA of ITR-2 or ITR-4.

– On sale: Based on the time duration between exercise and sale, either short-term or long-term capital gain will apply. This capital gain must be declared in Schedule CG of ITR-2 or ITR-4 so that tax may be suitably charged.

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13 Comments

  1. PrakashPrakash11-17-2016

    Hi Vijay,

    I have sold RSU stocks last fiscal year i.e 2015-16. But I by mistake filed my tax via ITR-1 and did not report this RSU selling.
    I hear I cannot revise my last year’s return since the due date was March-2016.

    Is there any option I can correct this ?

  2. SavioSavio07-30-2016

    Hi Vjay,

    Very informative article. Thanks!

    Can you please shed further light on RSUs under Sell-to-cover. This is for RSUs issued in the US (MNC) for a resident Indian.

    30.9% of the shares were sold on the day of vesting to cover perquisite tax by the employer. Now of what remained, is the entire amount taxable when the employee sells it (assuming there is a capital gain)?

    I am aware that based on the duration there could be STCG (less than 3 yrs holding) or LTCG (more than 3 years holding).

    Thanks in advance,
    Savio

    • Vijay PadiyarVijay Padiyar07-30-2016

      In case of capital gain, only the profit is taxed and not the entire investment amount.

      • SavioSavio07-30-2016

        Thanks for answering but can you clarify what you mean by profit? When we sell the shares, I assume what comes into our bank account is only the profit. Is this correct?

        So, we end up paying tax on the entire amount (as STCG or LTCG)?

        ~Savio

  3. ManishManish07-30-2016

    Hi
    You mentioned that grant RSU must be declared under financial interest section.
    But under what section it should come when it gets vested, Other Capital asset?

    • Vijay PadiyarVijay Padiyar07-30-2016

      You should continue to declare it in “B: Details of Financial Interest in any Entity Held” till it is sold.

  4. SekhonSekhon07-26-2016

    Hi Vijay,

    Thanks for this nice post!

    One doubt though about the minimum holding period for RSUs of an MNC. Would these not come under ‘equities’ and would not they be considered long term for capital gains if sold after 1 year just like any other equities/shares? Would they not be tax free after 1 year (long term capital gain for equities)?

    • Vijay PadiyarVijay Padiyar07-26-2016

      This is already answered in the blog post. Period for attracting long term capital gain is different for listed and unlisted shares. If the RSUs were listed on any Indian stock exchange then they would qualify for LTCG after a year.

  5. TIJU TITUS JOHNTIJU TITUS JOHN07-24-2016

    If the capital gain from Foriegn RSU/ESPP should be entered in Scedule CG or schdule FSI? Or do we need to mention at both sections

    • Vijay PadiyarVijay Padiyar07-24-2016

      To the best of my understanding it has to be declared in Schedule CG. Schedule FSI seems to be applicable to those who have earned foreign income or hold foreign assets while being abroad.

      • TijuTiju07-25-2016

        Your blog was very helpfull.

        Thanks
        Tiju

  6. monumonu07-23-2016

    hi vijay,

    Thanks for the details.
    It would have been good if you have shown some example to show what is to be filled where.
    I have a question regarding that:
    1. What is to be filled in total investment(at cost) for RSUs and ESPPs in Schedule FA part D. I understand that ‘income derived from asset’ and ‘income taxable and offered in this return amount’ should be same as u mentioned in the previous blog. What should be this value incase of capital gain/loss. Or this should be equal to ‘perquisite income’ as shown in 12B.
    For example:
    Perquisite income : 1000
    Income after sale : 800
    I incurred capital loss. I have to mention this loss in Schedule CG part A5. Where to mention this purchase cost and income after sale in A5. Help me with this.

    So two things where to fill these values in A5 as its not clear by name being a first timer and how to show these values in Schedule FA, both for RSUs and ESPPs

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