An overview of taxation on India ESOPs for US based NRIs

Employee Stock Option Plans (ESOPs) give employees a right to buy company shares at a pre-decided price and it forms part of taxable income. Most senior employees working with bluechip companies get ESOPs regularly and they have to pay tax on their ESOPs. When an Indian employee moves to the US to work there, he has to pay tax on his India ESOPs in US too, In this article we will explain how ESOPs are taxed in the US vis-s-vis India.
ESOPs can be taxed on two occasions: on exercising the option and on selling of exercised shares.

Taxation in India on exercising the option

It would be easier to understand the taxation on ESOPs with an example. Amit Verma is a 34 year old software engineer with one of India’s biggest software companies. Being a senior employee, he receives his ESOPs regularly in the form of company’s shares listed on the Indian stock exchange.

At the beginning of the next financial year, his ESOP of 50 shares got vested and he exercised the same at price of Rs 200 per share. The fair market value at that time was Rs 400 per share. Hence his perquisite value for taxation in India stood at Rs 200, that is, Rs 10,000 in toto. As he was in the highest income bracket, he had to pay tax at the rate of 30.9%, that is, Rs 3, 090.
Taxation in India on selling the exercised shares
In India the difference between the sale value and the market value at the time of exercising the option determines the capital gain on ESOPs. For example, if Amit sold his shares at Rs 500 per share, his capital gain per share would be Rs 100. The rationale behind this is that he has already paid the difference between the exercise value and market value, so now he must pay tax on excess only.

In India, long term capital gains tax is NIL if a share is sold after one year of purchase, on the contrary short term capital gain tax is levied at 15% if the share is sold within a year.

Taxation in US on exercising the option
It is mandated by the US tax law that a person who is a citizen or resident of the US must pay taxes on his global income. As is the case with India, in US too, the value of the ESOPs awarded is taxed right away when the employee exercises the option.

Suppose in 2011, Amit moved to the company’s US office in 2011. Now being a US resident, he is bound to pay taxes on his global income in the US, which includes the perquisite value of his India ESOPs. As per the prescribed exchange rate by the IRS, the ESOP perquisite value of Rs 10,000 would be USD 204. Amit is entitled to claim a tax credit in his US tax return since he has paid tax in India on this income. Using form 1116 he can claim a tax credit of USD 63 (Rs 3,090 converted at the rate of Rs49).

But there are certain limitations on the amount of credit you can claim. For example, the India tax credit you claim should not exceed the tax payable in the US on your Indian income.

Taxation in US on selling the exercised shares
In the US, the same method is applied to calculate capital gains as in India. The only difference is that there is no tax exempt on long term capital gains in the US. In the case of Amit, he is not entitled to pay taxes in India on his long term capital gains if he sells his shares after a year, but he has to pay taxes on those gains in the US. With reference to short term capital gains tax, he can claim a tax credit in his US tax return which is paid in India.

So as an US based NRI, when you exercise Indian ESOPs or sell Indian ESOPs, your taxation will not complete if you adhere to the Indian Taxation Rules. In addition to the Indian Taxation rules, you also need to comply with the US taxation rules.

The only good news is you will get tax credit in US tax return for the taxes you paid in India with reference to these ESOPs.