In the realm of talent retention strategies, Employee Stock Options (“ESOPs”) have emerged as a powerful tool on the global stage. As businesses span across borders, the allure of ESOPs extends to a myriad of international enterprises already operating within India’s domain. This phenomenon doesn’t end with domestic shores. Indian companies, too, have a unique vantage point. They have the capability to extend ESOP offerings to their personnel hailing from foreign holding/parent company or subsidiaries (“Group”). This interplay between entities from different corners of the world raises a significant consideration: the intricate cross charge of ESOP expenses. The delicate balance, where the implementing company navigates the allocation of ESOP costs to its foreign counterparts as employer company, forms one of the focal points in this whole (global and local) ESOP landscape in terms accounting and corporate taxation.
So is the case with Companies in India (“Indian Companies”) whose employees receive grant of ESOPs or issue of shares made by its Group company outside India . The later company use to cross charge the Indian Company that part of the ESOP accounting cost attributable to the grant made. This cross charge has been a requirement under the accounting standards of the relevant countries, somewhere also mandated by ESOP regulations, and in some cases also evidenced under a contract of cross charge signed by an Indian Company and its foreign Group company.
Discussion often surrounds the question of whether the cross charging of ESOP expenses by a foreign Group company to an Indian Company carries a potential obligation for tax withholding in India? This issue has been dealt with in well-established case of Hewlett Packard (India) Software vs. The Deputy Commissioner of the Income Tax, by the Income Tax Appellate Tribunal (“Tribunal”) Bangalore Benches.
Eligible employees of Hewlett Packard (India) Software P. Ltd. (“HP India”) had received shares from its parent company situated outside India (“HP Parent”) under HP India’ ESOP programs. HP India had incurred employee compensation expense equivalent to cost of shares being issued by HP Parent, which was claimed as a deductible expenditure by HP India. The Income Tax Dept among other disallowances, had claimed tax withholding on the cost of shares (also referred to as expenses) remitted to HP Parent under Section 195 of the Income Tax Act, 1961 (“Income-tax Act”).
The Tribunal held that tax withholding under Section 195 does not apply on remittance of cost of shares under an ESOP Plan, basis following principles:
- Indian company had implemented the ESOP plans contemplating issue of shares of its foreign Group company; thus, the responsibility of delivering of such shares rested with the Indian Company;
- Cost of shares was ultimately borne by the Indian Company being the employer as its own employees had received the equity benefits for their contribution to the business of the employer company in India;
- Cost is real, not notional and in fact is a business expenditure incurred for retention and motivation of employees for betterment of business;
- Such cost/ business expenditure has been treated as taxable salary in the hands of employees of Indian Company under Section 17 of the Income-tax Act; and
- Any tax withholding on this cost/ expenditure, if any, shall be from the employees’ salary as this forms part of employees’ perquisite. For this, Indian Company has already deducted tax at source (“TDS”) under Section 192 on the amount under reference as an employer and deposited with the Government.
Our broad observations:
Interpretation of the taxation statutes is done strictly basis what is stated in the relevant section(s). Provisions of Section 195 of the Act provides for deduction of TDS only in respect of “any sum chargeable to tax under the Income-tax Act”. In the absence of any “income” element in the subject remittance, there is “no sum chargeable to tax”. The cost of shares, under an ESOP plan, being remitted by an Indian Company does not contain any element of income for the recipient foreign Group company as the same is cost-to- cost reimbursement and hence the provisions of Section 195 of the Act would not apply.
The ratio of this case along with that in other similar cases provide a scope for a meticulous ESOP structuring envisaging cross border transactions with predictable tax implications resulting in certainty for the company management and saving of tax authorities’ valuable time.
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