Cross-border Issuance of ESOPs: Developing Indian Landscape | Article

Issuance of ESOP by Foreign Companies to resident Indian Employees

I. Background

Indian resident employees are increasingly granted stock options in the form of employee benefits schemes in their foreign parent companies. These options allow employees the right to subscribe to shares or other equity interests in the issuing foreign entity upon vesting. As per the Foreign Exchange Management Act, 1999 (“FEMA”) and the rules and regulations, an ‘employee benefits scheme’ is 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.” Therefore, this applies not only to Employee Stock Option Plans (“ESOPs”) but also includes schemes such as restricted stock unit schemes (RSUs), and employee stock purchase schemes (ESPS), amongst others.

II. Regulatory Framework

Since the issuance of ESOPs by a foreign company to employees residing in India at its Indian subsidiary involves the distribution of foreign securities, it qualifies as a capital account transaction, it is therefore subject to the FEMA and the rules and regulations issued thereunder. These include the following rules and regulations and are collectively referred to as the OI Regime:

(a) Foreign Exchange Management (Overseas Investment) Rules, 2022 (“OI Rules”);

(b) Foreign Exchange Management (Overseas Investment) Regulations, 2022 (“OI Regulations”); and

(d) Reserve Bank of India Master Direction on the Liberalised Remittance Scheme (“LRS”)

The OI Rules provide that Indian employees can acquire shares or similar equity interests in permissible foreign entities through ESOPs. The OI Regime contemplates two kinds of overseas investments: Overseas Direct Investment (“ODI”) and Overseas Portfolio Investment (“OPI”). The issuance of ESOPs is classified as an OPI only if they represent less than 10% of the total equity capital, whether listed or unlisted, of the issuing entity and do not confer any control, otherwise, they will be classified as an ODI.

III. Grant of ESOPs

The OI Rules allow foreign entities to grant ESOPs to resident Indian employees, subject to the following conditions:

(a) the individuals are employees or directors of the Indian office, branch, or subsidiary of the foreign entity, or of an Indian entity in which the foreign entity holds direct or indirect equity interests; and

(b) the ESOPs must be offered by the issuing foreign entity “globally on a uniform basis”

There is no specific guidance on the interpretation of “globally on a uniform basis” the intent of this rule suggests that it should be a comprehensive global scheme applied uniformly across all jurisdictions where the issuing foreign entity and its affiliates operate. In other words, the scheme in principle shall not vary with the scheme for other subsidiaries of issuing foreign entity globally i.e., the key rules in the scheme (vesting period, exercise price, lapse of award, etc.) shall be similar across all the subsidiaries of issuing foreign entity globally.

IV. Remittance of ESOPs

The LRS allows authorized dealer banks to permit remittances by resident Indian employees without RBI approval, up to USD 250,000 per financial year (April to March) for any permitted capital or current account transactions, or a combination of both. It is also important to note that, though there is no sub-limit on the amount of remittance made towards the acquisition of shares/interest under ESOP, such remittances are reckoned towards the LRS limit of the person concerned. For instance, if the resident Indian employee is required to remit USD 200,000 towards the acquisition of the ESOP shares, whilst such remittance will be permitted, such individual will be able to make any other overseas investments only up to USD 50,000 for that particular financial year without any approval.

An emerging issue on the issuance of ESOPs to employees in neighbouring countries

Share-based benefits are increasingly recognized as vital instruments for attracting and retaining talent, leading many companies to explore diverse structures for their implementation. Notably, foreign companies are actively issuing share-based benefits to Indian employees, while many Indian firms are also issuing ESOPs to their foreign workforce.

A recent development has brought the granting of ESOPs by Indian companies to foreign nationals from countries sharing land borders with India under regulatory scrutiny. The Government issued Press Note 3, which amended the FDI policy to mitigate the risk of “opportunistic takeovers or acquisitions of Indian companies” during the period of market turbulence caused by the COVID-19 pandemic. According to Press Note 3, “an entity of a country that shares a land border with India, or where the beneficial owner of an investment into India is situated or is a citizen of such a country, may invest only under the government route.” Regulatory authorities appear concerned that ESOPs could potentially be utilized to circumvent these restrictions. Under Press Note 3, India recognizes Pakistan, Afghanistan, Nepal, Bhutan, China (including Hong Kong), Bangladesh, and Myanmar as countries sharing land borders with India.

However, there remains some ambiguity regarding whether ESOPs would fall within the restrictions outlined in Press Note 3. One perspective is that ESOPs may not fall under the restrictions outlined in Press Note 3, since the threshold to identify ‘beneficial owners’ under Indian laws is at least 10% equity ownership or control of a company. The shares issued upon the exercise of ESOPs typically represent less than 10% of equity and do not confer control. Moreover, the question of beneficial ownership becomes relevant only at the point of share exercise, not at the time of grant. On the other hand, some experts argue that since prior government approval is required for foreign investments in a company, this requirement should logically extend to ESOPs as well, even at the time of their grant of ESOPs.

Therefore, the issue of cross-border ESOPs is critical for both Indian and foreign companies, particularly as regulatory scrutiny in this area intensifies. Companies must navigate these complexities carefully to ensure compliance while effectively utilizing share-based benefits in their compensation strategies.

Authors:

Gyanendra Mishra, Partner

Mudrika Purohit, Associate

Disclaimer: The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.