1. 2007 Update on Granting Stock
Options in India
by fred m. greguras, s.r. gopalan and tahir j. naim
This is an overview of some of the legal and strategic issues Effective with the publication on April 5, 2006 of RBI/2005-
related to a U.S. parent company granting stock options to 06/253, the Reserve Bank of India (“RBI”) allows authorized
employees of its Indian subsidiary, including consideration of foreign exchange dealers to handle remittances abroad for
exchange controls, securities laws and tax burdens. acquiring shares under stock option plans, provided the
dealer verifies: (i) the foreign issuer owns at least 51% of the
strategy India subsidiary that employs the employees exercising the
stock options; (ii) the shares are being offered by the foreign
Before implementing a compensation scheme, a company issuer globally on a uniform basis (which we understand to
must evaluate its likely effectiveness in incentivizing and mean that the stock option program in India should not have
retaining employees. Options, to the extent they inspire terms that are different from the terms generally applicable
loyalty and commitment and provide employees with a sense to employees elsewhere in the world) and (iii) the India
of ownership, are an important compensation tool. Indian subsidiary files an annual return with the RBI disclosing the
employees in the information technology and biotechnology remittances and the beneficiaries that is submitted to the RBI
sectors generally are familiar with this type of compensation through an “Authorised Dealer” bank). The requirements for
and at least higher level employees view options favorably. global uniformity and for filing of annual returns apply to all
Lower level employees may prefer cash. employers in India.
securities law considerations The RBI has also granted general permission to foreign
companies to repurchase shares issued to their employees
India’s securities laws do not impose any restrictions on
in India under a stock option plan. Previously, such a
the grant to employees in India of stock options by a U.S.
repurchase required advance approval from the RBI. Now
company. Companies may offer stock options to employees
such approval is unnecessary if the following requirements
of a subsidiary in India either directly or indirectly. U.S.
are met: (i) issuance of the shares was in accordance with
securities laws will not be an issue so long as the options are
the exemptions above, (ii) the terms of the repurchase were
granted under a plan which is either in compliance with Rule
specified in the initial option agreement (and have not been
701 of the U.S. Securities and Exchange Commission (“SEC”)
amended since); and (iii) the India subsidiary is current in
and applicable state law or has been registered with the SEC
filing its annual returns with the RBI providing details of
on a Form S-8 registration statement.
remittances/beneficiaries/etc.
currency control considerations
The general authorization for repurchase of shares appears
India’s currency exchange controls applicable to option to be in addition to the existing general permission to the
exercises by employees have been liberalized. There is optionees to sell their shares after exercise. A voluntary sale
presently no limit on the amount that employees or directors by the employee (unlike an involuntary repurchase compelled
are allowed to remit for this purpose so long as the U.S. by the employer in compliance with the above requirements)
company owns at least 51% of the India subsidiary and is subject to the condition that the sale-proceeds are
any proceeds from a sale of the shares is repatriated to immediately remitted to an account with an “Authorised
an account in India. A purchase of U.S. company shares Dealer” bank in India (in any case not later than 90 days from
by persons other than employees or directors of the India the date of such sale).
subsidiary, under an equity incentive plan or otherwise,
remains subject to monetary limits (presently $50,000 per
year per Indian resident) under India’s foreign exchange
control regulations.
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2. employment issues of 33.99% on the difference between the price paid for the
shares and the fair market value of those shares on the date
Like the United Kingdom, employees in India generally of exercise. FBT applies to any exercise of a compensatory
have a written employment agreement. If the employment stock option by an employee that occurs after March 31, 2007,
agreement expressly states that the grant of equity regardless of when the option was granted. The Indian tax
compensation is entirely within the employer’s discretion, authorities have announced their view that employers based
or makes no mention of equity compensation being part of outside India, even those with no permanent establishment
the employee’s pay, then it is unlikely that an employee can in India, are nonetheless liable for payment of the FBT.
claim any special or ongoing entitlement to additional equity
compensation although there is no harm in expressly stating Since the application of FBT to stock options has been
this in the stock option agreement. extended on such short notice, employers across India are
still evaluating how to manage the additional impact on their
data privacy bottom lines. An initial response is to provide in the stock
option agreement that the employer can withhold from the
Data privacy is a concern around the world now, no less
employee’s exercise a number of shares equal to the FBT
in India than in the U.S., so it is advisable to obtain the
or the required amount of cash from the employee’s pay.
employee’s consent to sharing personal information with
This is similar to what is done by employers in the United
persons outside India as part of the administration of the
Kingdom with respect to a UK health insurance tax imposed
stock option program. India’s close legal history with
on employers when a stock option is exercised. This would
the United Kingdom suggest it may eventually follow the
be a prospective approach only, as currently outstanding
European Union’s privacy practices to an even greater degree.
stock options could not have this burden imposed without
obtaining the optionholder’s consent. However, recovery
tax consequences
of FBT from the employee is taxable income to the employer
Income Tax at a rate of 33.99%. Thus, for the employer to be indifferent
As of April 1, 2007, when India’s 2007-2008 government to the imposition of FBT under this approach would require
budget took effect, the exercise of a stock option by an the employee to reimburse the employer for this tax (and
employee in India is no longer subject to income tax on the the tax on this additional reimbursement and so on). It
difference between the price paid for the shares and the becomes apparent that this approach represents a significant
fair market value of those shares on the date of exercise. diminishing return to the employee and is something of a
Instead, the employer will pay a flat fringe benefits tax (“FBT”) mathematical headache for the employer. Therefore, the
of 33.99% on the difference between the price paid for the employer either will:
shares and the fair market value of those shares on the date
of exercise. n Limit recovery of FBT from the employee to the amount of
the original FBT, or
Previously, the imposition of the employee’s liability for
income tax on a stock option exercise could have been n Absorb the FBT as a cost of doing business (possibly by
deferred to the date of sale of the shares, if the plan complied limiting the value of any option exercise in a given year in
with certain tax guidelines and had been registered with proportion to the amount of FBT the employer will face as
India’s Chief Commissioner–Income Tax of the state where a result), or
the subsidiary is incorporated. The benefit from options
granted under these plans is now mooted as income tax is n Cease granting stock options to employees in India.
no longer imposed on the employee upon exercise. At the
time the employee sells the shares the employee is subject Another approach that employers can use to mimic the
to income tax on the difference between the amount realized effect of stock options is an award of cash-settled stock
from the sale and the fair market value of those shares on the appreciation rights, as the payment is taxable income to the
date of exercise (rules for how fair market value on the date of employee rather than subject to FBT paid by the employer.
exercise is to be determined are still being developed). However, U.S. accounting rules will treat these awards as
liabilities rather than equity.
Fringe Benefits Tax
As noted above, as of April 1, 2007, the exercise of a stock
option by an employee in India subjects the employer to FBT
007 update on granting stock options in india fenwick west

3. It has been suggested by some, that it might be possible
for the employer to avoid the FBT by classifying as a cash
bonus by permitting option exercises to only occur through
a “sell-all” program (whereby employees of publicly-traded
companies instruct a stockbroker, retained by the issuing
company, to sell a number of shares subject to the option into
the market and use the sale proceeds to fund the exercise
of the option with the remaining cash then delivered to the
employee so the employee never has more than fleeting
physical control of shares). However, we are informed that
the Indian tax authorities view such an approach as subject
to FBT.
conclusion
Overall, India presents a welcome climate for investment, but
the fact that this law applies to stock options granted prior to
its taking effect will give many investors pause, as it signals
the willingness of the Indian government to unexpectedly
shift a tax liability to the employer, who provided the stock
option to the employee at a time when the employer thought
the tax burden was borne by the employee who stood to reap
the taxable benefit.
Nonetheless, some employers may still believe it worthwhile
to implement an equity-based compensation program in
India, perhaps using restricted stock awards or limiting
stock option exercises in such a way as to avoid more than
a predictable amount of FBT in any given year (a potentially
complicated exercise), in order to attract and retain
employees. Such employers therefore, should consult with a
chartered accountant or attorney in India to evaluate the best
approach under the circumstances and with the knowledge
that those circumstances may be subject to unexpected
change.
If you have any questions about this memorandum, please
contact Fred M. Greguras (fgreguras@fenwick.com) or Tahir J.
Naim (tnaim@fenwick.com) of Fenwick West LLP (telephone:
650.988.8500) or S.R. Gopalan of Dawn Consulting in
Bangalore, India (srg@dawnconsulting.com).
©2007 Fenwick West LLP. All rights reserved.
IRS circular 230 disclosure: to ensure compliance with requirements imposed
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(including attachments) is not intended or written by Fenwick West LLP to
be used, and cannot be used, for the purpose of (i) avoiding penalties under
the internal revenue code or (ii) promoting, marketing, or recommending to
another party any transaction or matter addressed herein.
007 update on granting stock options in india fenwick west